* BOJ's bond-offer reduction a prelude to formal cut to purchases
* BOJ seen holding off on rate hike until September, says Momma
* Consumption rebound, higher service prices needed to hike rates
* BOJ board next meets for rate review on June 13-14
TOKYO, May 14 (Reuters) - The Bank of Japan (BOJ) may decide to reduce the size of scheduled bond buying next month to resuscitate a bond market left largely dysfunctional by its continued huge purchases, former central bank executive Kazuo Momma told Reuters.
But the BOJ is likely to wait at least until September in raising interest rates to scrutinise whether wages, consumption and service-sector prices rise enough to keep inflation durably around its 2% target, Momma said in an interview on Tuesday.
"Compared with ending negative rates, hiking short-term rates to 0.25% would have a bigger impact on the general public by pushing up mortgage loan rates and smaller firms' borrowing costs," he said.
"The BOJ needs to convince the public that raising rates is necessary," which means it must wait for consumption to emerge from the doldrums, said Momma, who retains close contact with incumbent policymakers.
Currently an executive economist at private think tank Mizuho Research & Technologies, Momma oversaw the BOJ's economic analysis and monetary policy drafting before retiring from the central bank in 2016.
The BOJ ended eight years of negative interest rates and other remnants of its radical stimulus in March as it judged that sustained achievement of its 2% inflation target was in sight.
But the central bank still guides short-term rates around zero and has pledged to buy Japanese government bonds (JGB) at roughly 6 trillion yen ($38.4 billion) per month to avoid any spike in borrowing costs from hurting the fragile economy.
Along with the timing of the next rate hike, markets are focusing on how soon the BOJ could start reducing the size of its scheduled bond purchases.
Momma said the BOJ was already laying the groundwork to cut bond buying, as seen by its surprise move on Monday to make an unannounced reduction to the amount of bonds it offered to buy in regular market operations.
Monday's move was likely an attempt by the BOJ to check whether markets were ready for a more full-fledged cut to its bond buying, Momma said. It was also a signal to investors that further tapering could come soon, he added.
"The BOJ is starting to prepare for a formal reduction in its bond buying. There's a good chance it could decide to slash its (scheduled) bond purchases at the next policy meeting in June," Momma said.
The BOJ may either slow monthly purchases to around 4-5 trillion yen, or commit to reducing the outstanding balance of bond holdings by a certain amount by year-end, Momma said.
BOJ Governor Kazuo Ueda has said the central bank will start reducing its bond purchases once markets stabilise from any shock caused by its March policy shift.
Momma also said the BOJ could raise short-term rates to 0.25% in September, when the government's monthly wage data for July and August will be available to confirm whether bumper pay hikes offered by big firms have actually reached households.
Waiting until September would also give the BOJ enough time to check whether rising labour costs have prodded firms to raise prices for services, and whether consumption will rebound, he added.
The impact on consumption from rising living costs has dragged on Japan's economy, which likely contracted an annualised 1.5% in the first quarter, according to a Reuters poll.
"The BOJ will probably want to wait until second-quarter gross domestic product (GDP) data, due out in August, point to a consumption recovery," Momma said. "That means the fastest timing it could hike rates would be in September."
The BOJ may then raise short-term rates to 0.5% in January or March, and to 0.75% later next year, though there was uncertainty on how much further it could hike thereafter, he added.
($1 = 156.3800 yen) (Reporting by Leika Kihara Editing by Shri Navaratnam)
