Analysis-BOJ faces new challenges as policy, yen complicates rate hikes Reuters

By Leica Kihara

TOKYO (Reuters) – Bank of Japan Governor Kazuo Ueda’s efforts to lift borrowing costs from record lows face fresh challenges as a rebound in the yen and the new political leadership’s preference for loose monetary policy raise the bar for rate hikes interests.

Japan’s new prime minister, Shigeru Ishiba, stunned markets this week when he said the economy was not ready for further interest rate hikes, an apparent shift from his previous support for the BOJ, which has run decades of extreme monetary stimulus.

The surprisingly dovish comments pushed the yen lower against the dollar and raised fresh doubts about how aggressive the BOJ would be in raising interest rates.

While the policy is unlikely to derail the longer-term case for raising interest rates, analysts say policy deliberations could become bumpy ahead of the October 27 general election.

“I don’t think the remarks were meant to put huge pressure on the BOJ. Rather, Ishiba probably had the election on his mind,” said Katsuhiro Oshima, chief economist at Mitsubishi UFJ (NYSE: ) Morgan Stanley Securities. “He was seen by the markets as a hawk, so maybe he wanted to adjust that image a little bit.”

Elections looming this month mean many analysts expect the BOJ to hold off on raising rates at its Oct. 30-31 meeting.

Ueda was appointed last year by former Prime Minister Fumio Kishida, who resigned in September and approved the BOJ’s exit from its radical monetary stimulus.

The BOJ in March marked its first rate hike in 17 years, arguing that the pace of rising prices and wages showed Japan was finally shaking off its entrenched deflationary mindset.

However, the bold move to a tightening trend hit a snag this week, with Ishiba’s new cabinet reaffirming with the BOJ a 2013 statement that forces both sides to focus on relaunching a stagnant economy.

Of course, pressure for the BOJ to immediately raise rates again this year had already eased before Ishiba took office, thanks in part to a rebound in the yen from a three-decade low hit in July that moderates inflationary pressure from import costs . .

Anticipating political clouds, the BOJ has already set the stage for a break. After holding rates steady last month, Ueda signaled the BOJ was in no rush to hike, with markets still volatile and U.S. economic uncertainties rising.

“They won’t directly affect monetary policy,” a source familiar with the BOJ’s thinking said of Ishiba’s remarks. “But there’s also no need for the BOJ to raise rates when there’s so much going on,” the source said, a view echoed by another source.

POLITICAL UNCERTAINTY MAY CONTINUE

After ending negative interest rates in March and raising them again in July, Ueda said the BOJ would continue to raise rates to levels that would neither cool nor overheat growth – seen by analysts as somewhere around values ​​of 1-1.5% – if the economy will move in accordance with forecasts. .

With inflation above 2% for more than two years and a tight labor market pushing up wages, breaks that are too long could cause communication problems.

However, given the potential for political twists and turns heading into the election, the BOJ may use overseas risks, such as a slowing US economy, as an argument not to raise rates immediately.

Such a change in messaging could help avoid a market perception that the BOJ is abandoning its tightening bias altogether.

“It is essential that the BOJ works to improve its communication to avoid unnecessary confusion with its policy shift,” BOJ board member Asahi Noguchi said Thursday in unusually candid remarks, acknowledging problems in how the central bank communicated with the markets.

There is also uncertainty over whether Ishiba will return to his support for exiting the BOJ once the election is out – as many policymakers and analysts expect.

Ishiba’s approval ratings stood at 50.7 percent in a poll by the Kyodo news agency between Oct. 1 and 2, lower than the debut ratings of the previous three administrations, suggesting a tough election battle.

While Ishiba’s Liberal Democratic Party (LDP) is likely to remain in power, a significant loss of seats could weaken his standing within the party and put him under pressure to meet demands for fiscal and monetary policy lax, analysts say.

Depending on the outcome of this month’s lower house elections, political uncertainty may continue until next summer’s upper house elections.

“If Ishiba wins solidly in this month’s election and the political situation stabilizes, the BOJ could raise rates in December or January,” said Shigeto Nagai, head of Japan economics at Oxford Economics.

“If the political turmoil drags on, that could unravel the BOJ’s strategy to raise rates to around 0.75% next year,” he said. “Essentially, the BOJ probably wants to move quickly.”