Analysis-Political uncertainty could prompt BOJ to pause, but not end, rate hike trajectory By Reuters

By Leica Kihara

TOKYO (Reuters) – Political uncertainty left by Prime Minister Fumio Kishida’s decision to step down is likely to lead to a pause, rather than a halt, in the Bank of Japan’s plan to steadily raise interest rates from near-zero levels.

How long that pause could last will depend not only on how the race for the leadership of the ruling party plays out, but also on how market movements affect the political debate over the preferred pace of rate hikes, analysts say.

Kishida, who picked Kazuo Ueda as BOJ governor last year, said on Wednesday that he will not participate in the leadership race of the ruling Liberal Democratic Party (LDP) in September.

The BOJ worked closely with the Kishida administration to preach the benefits of higher wages. Days before the BOJ’s interest rate hike in July, Kishida said the central bank’s policy normalization would support Japan’s transition to a growth-based economy, in a sign of his support for an exit from ultra-low interest rates.

Kishida’s departure leaves a political vacuum that increases uncertainty over economic policy and complicates the BOJ’s efforts to lead a smooth exit from easy monetary conditions in coordination with the government.

Those seen as front-runners have largely advocated gradual increases in Japan’s current ultra-low interest rates, partly as a means of staving off sharp declines in the yen.

Shigeru Ishiba, seen as a favorite to succeed Kishida as the next LDP leader and thus prime minister, told Reuters the BOJ was “on the right political track” in gradually raising rates.

Other leading candidates, such as party heavyweights Toshimitsu Motegi and Taro Kono, also called for higher interest rates and demanding communication from the BOJ.

The only proponent of aggressive easing is black candidate Sanae Takaichi, who belongs to a party group that supported former Prime Minister Shinzo Abe’s stimulus policies.

“Takaichi might be an exception, but most candidates don’t seem to be against the BOJ’s policy normalization. If so, there won’t be much disruption to the bank’s way of raising rates in the long run,” said veteran BOJ watcher Mari Iwashita.

POLICY-TENSION BOJ

By law, the BOJ is granted independence from government interference in setting monetary policy. But it has historically come under political pressure to use its monetary easing tools to revive the economy.

This political tension is partly driven by the government’s power to appoint BOJ board members, including the governor, which then needs parliamentary approval to take effect.

With the weak yen intensifying pressure on households from rising living costs, many policymakers are likely to agree to gradual rate hikes for now, analysts say.

This means the BOJ will likely stay the course and continue to raise rates – albeit at a slower pace than originally thought.

A survey conducted by the think tank Japan Center for Economic Research between July 30 and Aug. 6 showed that many economists project another rate hike by the end of the year.

“The weak yen has been enemy No. 1 for many lawmakers, which means there is less political pushback against interest rate hikes than in the past,” said a source familiar with the BOJ’s thinking.

BREAK TIME

Data showing the economy rebounded in the second quarter on robust consumption is helping to justify further rate hikes, analysts say.

The BOJ has too much to lose by abandoning a carefully crafted plan to undo a sweeping decade-long stimulus program that ended negative rates in March and pushed short-term rates up to 0.25% from 0-0.1. % in July.

The BOJ remains a global monetary policy outlier. The central bank has kept rates very low, even as its counterparts in the US and Europe hike aggressively from 2022 to combat raging inflation. Now, the BOJ is raising rates while its peers have begun to ease, and yet it is far from normalizing policy.

Governor Ueda said further rate hikes were necessary adjustments to excessive monetary support rather than full-fledged tightening – a position he is likely to maintain.

But the BOJ also has good reason to ride out the storm, holding hands at its next policy meeting on September 19-20, which is likely to be close to the date of the LDP leadership race.

The US presidential election could also increase market volatility and prevent the BOJ from acting on a further rate review on October 30-31, analysts say.

“The BOJ will hold off on rate hikes until at least December when political events in Japan and the US take their course,” said Toru Suehiro, chief economist at Daiwa Securities.

The BOJ would also need time to build trust with the new prime minister, who may have to wait until November to be approved by parliament.

An academic turned governor, Ueda has few associates in political circles, adding to the challenges of communicating smoothly with the new administration, some analysts say.

There is no guarantee that policymakers will continue to favor rate hikes if the yen’s downtrend reverses.

A rally in the yen, caused in part by the BOJ’s interest rate hike in July, led to a drop in stock prices, forcing the central bank to back off its dovish communication path.

“If the yen’s weak tide reverses, some policymakers may start to question whether the BOJ needs to raise rates further,” said Naomi Muguruma, chief bond strategist at Mitsubishi UFJ (NYSE: ) Morgan Stanley Securities.