The Bank of Japan on Tuesday kept monetary policy on hold but expanded a loan scheme targeting growth industries, keeping up efforts to address chronic ills that have been plaguing the economy even before a devastating earthquake struck in March.

The central bank reiterated its forecast that the world's third-largest economy should resume a moderate recovery before the end of the year despite recent signs of a global slowdown.

It also sounded less concerned than last month in describing current economic conditions, reflecting the steady progress manufacturers are making in restoring supply chains which were disrupted by the March 11 quake and tsunami.

We're seeing some positive surprises for Japan's economy short-term, BOJ Governor Masaaki Shirakawa told a news conference, citing resilience in factory output and capital spending.

Global growth will remain strong and support Japan's recovery after it overcomes supply constraints, he said, signaling that no imminent monetary easing was on the horizon.

As widely expected, the central bank, which eased policy by doubling asset purchases days after the March 11 disaster, held fire on further asset buys and kept interest rates in a 0-0.1 percent range.

But it added 500 billion yen ($6 billion) to its 3-trillion-yen loan scheme aimed at encouraging banks to lend to industries with growth potential.

The new money would be offered under a new credit line for banks that lend against inventory and receivables as collateral. That would make funds more available to small firms that do not own property -- a standard collateral for bank loans.

The scheme is part of a long-term effort to nurture economic growth, which is being weighed down by an aging population, low productivity and grinding deflation.

TOO OPTIMISTIC?

The BOJ toned up its view on the economy, saying it was under downward pressure but was showing some signs of picking up. Last month the central bank said the economy was under strong downward pressure.

But Shirakawa stressed that the BOJ was maintaining its easy policy bias and warned that power shortages may remain a long-term drag on economic growth if Japan reduces reliance on nuclear energy.

Some analysts warned that the BOJ might be too optimistic about the outlook and should focus on propping up near-term growth rather than worry about Japan's long-term problems.

The truth is there are more reasons to be concerned about the outlook than to be optimistic. Reconstruction demand isn't coming as soon as many people were expecting, which we saw in weak machinery orders data, said Tetsu Aikawa, deputy general manager of capital markets at Shinsei Bank in Tokyo.

Among the concerns is that reconstruction spending may get delayed, given Prime Minister Naoto Kan's struggle to stay in power and get disaster-related bills passed in a parliament where the opposition controls the upper house.

Finance Minister Yoshihiko Noda said the government planned to follow up an extra 4 trillion yen budget passed in May with another one early in July, but it is far from certain if it will win needed opposition backing.

Japan is slowly emerging from its worst crisis since World War Two after the magnitude 9.0 earthquake and ensuing tsunami hit its northeast coast on March 11, triggering meltdowns at a nuclear power plant and pushing the economy into its second recession in three years.

A government survey of big Japanese manufacturers supported the recovery scenario. While business sentiment dived in the April-June quarter, firms ramped up capital expenditure plans for the fiscal year that started in April.

Under the loan scheme introduced in mid-2010 to support 18 growth industries such as clean energy and nursing care, the BOJ offers 0.1 percent, one-year loans to banks that lend to companies from the targeted sectors. The loans can be rolled over three times, so banks can lend for up to four years.

It is the BOJ's long-term approach to beat deflation and is separate from its asset buying program, introduced in October 2010 as a direct, short-term monetary easing measure.

To encourage banks to extend longer-term loans, the BOJ will offer them two-year loans and allow them to be rolled over once, meaning banks can borrow from the BOJ for up to four years. The BOJ hopes the new credit line will help boost asset-based lending in Japan which, at roughly 300 billion yen, is still small in size.

($1 = 80.225 Japanese Yen)

(Additional reporting by Rie Ishiguro; Editing by Tomasz Janowski)

Japan Inflation