By Leika Kihara

TOKYO (Reuters) - Bank of Japan Deputy Governor Ryozo Himino said the central bank must be "very vigilant" to the impact the yen's moves could have on the economy, suggesting the currency's weakness will be among factors affecting the timing of its next interest rate hike.

However, he said it was inappropriate for central banks to directly target exchange rates in setting monetary policy, as other factors needed to be considered as well.

"Exchange-rate fluctuations affect economic activity in various ways. It also affects inflation in a broad-based and sustained way, beyond the direct impact on import prices," Himino said on Tuesday.

"That's why we obviously need to be very vigilant to, and analyse very closely, the impact of exchange-rate volatility on the economy, prices and their outlook," he said in a panel session hosted by Columbia University in Tokyo.

The BOJ shouldn't automatically respond to exchange-rate moves in setting interest rates, though, as there were "other aspects" that need to be taken into account such as the economic and price outlook, he added.

A weak yen has become a headache for Prime Minister Fumio Kishida's administration, which has seen its approval ratings slump as the currency's decline pushed up households' cost of living by inflating the price of importing food and fuel.

BOJ Governor Kazuo Ueda has ruled out using monetary policy to directly influence exchange-rate moves, but signalled the chance of raising rates if the weak yen pushes up inflation more than expected.

Many market players expect the BOJ to raise interest rates from current near-zero levels this year with some expecting a move as early as July, partly to slow the yen's persistent decline.

Asked what the central bank would do with its huge balance sheet, Himino said the BOJ would make a decision focusing on how it would affect the economy, prices and its goal of sustainably achieving its 2% inflation target.

"It's desirable for markets to set long-term interest rates. On the other hand, the BOJ has been deeply involved in the bond market up till very recently and our presence remains very large. We need to avoid causing discontinuity or any unintended moves in the market," Himino said.

The remarks underscore the tricky balancing act the BOJ faces in allowing market forces to drive long-term interest rates higher, while avoiding an abrupt spike in bond yields.

In March, the BOJ ended eight years of negative interest rates and a policy capping long-term borrowing costs around zero dubbed yield curve control (YCC).

The decision was partly aimed at breathing life back to a market made dormant by the BOJ's huge presence, and allowing market forces to drive yield moves.

Markets are focusing on whether the BOJ, at its next policy meeting on June 13-14, will move to a full-fledged reduction in its huge bond purchases.

The 10-year government bond yield briefly jumped to 1.1% last week, the highest level since July 2011, on growing expectations of a near-term interest rate hike.