By Leika Kihara
TOKYO (Reuters) – Political uncertainty created by Prime Minister Fumio Kishida’s decision to resign is likely to lead to a pause rather than a complete halt in the Bank of Japan’s plan to raise interest rates steadily from near-zero levels.
How long that pause might last depends not only on the outcome of the race for the party leadership, but also on how market movements affect the political debate about the desired pace of interest rate hikes, analysts say.
Kishida, who personally appointed Kazuo Ueda as governor of the BoJ last year, said on Wednesday that he would not run in the election for chairman of his ruling Liberal Democratic Party (LDP) in September.
The BOJ worked closely with Kishida’s government to preach the benefits of higher wages. A few days before the BOJ’s July rate hike, Kishida said the normalization of the central bank’s monetary policy would support Japan’s transition to a growth-oriented economy, signaling his support for an exit from ultra-low interest rates.
Kishida’s departure leaves a political vacuum that increases economic policy uncertainty and complicates the BOJ’s efforts to implement a smooth exit from its loose monetary policy in coordination with the government.
The most promising candidates are seen as advocates of a gradual increase in Japan’s currently extremely low interest rates, partly to keep a sharp decline in the yen in check.
Shigeru Ishiba, who is considered the favorite to succeed Kishida as the next LDP chairman and thus prime minister, told Reuters that the BOJ was “on the right political path” with its gradual interest rate hike.
Other leading candidates such as party heavyweights Toshimitsu Motegi and Taro Kono also called for higher interest rates and more aggressive communication from the BOJ.
The only supporter of aggressive easing is outsider candidate Sanae Takaichi, who belongs to a party group that supported former Prime Minister Shinzo Abe’s stimulus policies.
“Takaichi may be an exception, but most candidates do not seem to be against normalizing BOJ policy. If that is the case, there will be no major disruptions to the bank’s long-term rate hike path,” said veteran BOJ observer Mari Iwashita.
TENSIONS BETWEEN POLITICS AND BOJ
The BOJ is legally independent of government interference in setting its monetary policy, but in the past it has come under political pressure to use its monetary easing measures to revive the economy.
These political tensions are partly due to the government’s power to appoint BOJ board members, including the governor, and the approval of parliament is required for these appointments to take effect.
With the weak yen putting pressure on households through rising living costs, many politicians are likely to agree to gradual interest rate hikes for the time being, according to analysts.
This means that the BoJ is likely to maintain its course and continue to raise interest rates – albeit more slowly than initially expected.
A survey conducted from July 30 to August 6 by the Japan Center for Economic Research think tank found that many economists predict another interest rate hike by the end of the year.
“The weak yen is enemy No. 1 for many policymakers, meaning there is less political resistance to rate hikes than in the past,” said a source familiar with the BOJ’s thinking.
MOMENT TO pause
Data showing the economy recovered in the second quarter on the back of robust consumption is helping analysts justify further interest rate hikes.
The BOJ has too much to lose by abandoning a carefully crafted plan to unwind a decade-long radical stimulus program that ended negative interest rates in March and led to a hike in short-term rates from 0-0.1% to 0.25% in July.
The BOJ remains a global outsider in its monetary policy. The central bank kept interest rates extremely low even as its U.S. and European counterparts have been aggressively raising them since 2022 to combat sweltering inflation. Now the BOJ is raising rates while its counterparts have started easing, and yet it is still far from normalizing its policy.
Governor Ueda said further rate hikes would be a necessary adjustment of excessive monetary support, not a comprehensive tightening of monetary policy, a stance he is likely to maintain.
But the BOJ also has good reasons to ride out the storm by remaining unchanged at the next monetary policy meeting on September 19 and 20 – probably in time for the election campaign for the LDP chairmanship.
The US presidential election could also increase market volatility and prevent the BoJ from taking action when it holds another interest rate review on October 30 and 31, analysts say.
“The BOJ will wait to raise interest rates at least until December, until political events in Japan and the US have taken their course,” said Toru Suehiro, chief economist at Daiwa Securities.
In addition, the BOJ would need time to build trust in the new prime minister, who may have to wait until November for confirmation by parliament.
Ueda, an academic turned governor, has few acquaintances in political circles, making smooth communication with the new administration even more difficult, some analysts say.
There is no guarantee that policymakers will continue to support interest rate hikes if the yen’s downward trend reverses.
A sharp rise in the yen, caused in part by the BoJ’s interest rate hike in July, caused stock prices to collapse and forced the central bank to back away from its hawkish stance.
“If the yen’s weakness reverses, some policymakers may start to question whether the BoJ needs to raise interest rates further,” said Naomi Muguruma, chief bond strategist at Mitsubishi UFJ Morgan Stanley Securities.
(Reporting by Leika Kihara; Editing by Shri Navaratnam)
