Analysis-Shadow of Abenomics clouds BOJ rate hike path by Reuters

By Leica Kihara

TOKYO (Reuters) – Political uncertainty and the surprising prominence of a right-wing candidate in the race to lead Japan’s ruling party could add pressure on the central bank to slowly raise interest rates further from record lows.

Already, the Bank of Japan (BOJ) has softened some of its signals about future interest rate hikes as US recession risks and jittery financial markets cloud the economic outlook.

Now a new complication comes from politics, as the race on Friday to elect the new leader of the ruling Liberal Democratic Party (LDP), who in turn becomes the next prime minister, heats up.

Sanae Takaichi, 63, a supporter of the late former prime minister Shinzo Abe’s “Abenomics” stimulus policies, appears to be among three of the nine candidates likely to make it to the round.

The one-time candidate, who could become Japan’s first female leader, is a single but vocal opponent of further interest rate hikes.

“What we’re seeing now is cost-push inflation. We need to maintain accommodative monetary policy until real wages become stably positive,” Takaichi told reporters on September 19.

“I think it would be foolish to raise interest rates now,” she said in an interview broadcast online Monday, warning that doing so could push Japan back into deflation.

Opinion polls show Takaichi and two other candidates, former defense minister Shigeru Ishiba and former environment minister Shinjiro Koizumi, in the lead.

Some analysts believe Ishiba and Koizumi have an edge over Takaichi, although polls show the race is too close to count.

“If Takaichi wins, the market’s initial reaction would be a lower yen as the market prices the chance of a delay in future rate hikes,” said Naomi Muguruma, chief bond strategist at Mitsubishi UFJ (NYSE: ) Morgan Stanley Securities.

THE RHETORIC OF “DEFLATION” RETURNS

Under pressure from then-prime minister Abe, the BOJ implemented sweeping stimulus in 2013 that turned into a complex policy package to lift anemic inflation toward the bank’s 2 percent target.

As rising commodity costs and a tight labor market pushed up inflation and wages, the BOJ exited policy in March and raised rates to 0.25 percent in July under Governor Kazuo Ueda.

The departure of Prime Minister Fumio Kishida, who appointed Ueda and broadly supported the end of massive monetary stimulus, is just a blow to the bank’s exit strategy, analysts say.

“Things will not go better for the BOJ than when Kishida was prime minister, no matter who wins the LDP race,” said former BOJ board member Takahide Kiuchi, who is currently an economist at the Nomura Research Institute. “The BOJ will find it very difficult to raise rates if Takaichi wins.”

Even if Takaichi does not become prime minister, a strong performance in the race could help her land a key cabinet post and put pressure on the next prime minister, some analysts say.

Currently economic security minister, Takaichi has the support of reformist-minded lawmakers and academics who played a key role in Abenomics, such as Etsuro Honda (NYSE: ), who was Abe’s economic aide.

Abe resigned as prime minister in 2020 and was assassinated in 2022.

Although his death and a rise in inflation pushed the refretionist lobby to the back burner, high spending and ultra-low interest rates remain popular among conservative PDL supporters, complicating Tokyo’s efforts to end its reliance on heavy stimulus.

Despite its institutional independence, the BOJ is sensitive to political discontent over its policies and has become a target of public anger in the past, with many blaming the decade-long economic stagnation that began in the late 1990s on premature tightening.

While only PLD party members and lawmakers vote in Friday’s contest, some members of the public praised Takaichi’s economic plans.

“Among the nine candidates, she (Takaichi) has clearly stated that she will protect the country and its people and invest money in areas where it is needed to boost economic development and revive Japan’s economy,” said Tomoko Abo, a 59-year-old person. -old resident of Osaka. “Such thoughts make me feel that Japan has a bright future.”

In a nod to political concerns over higher borrowing costs, Ueda said in a speech on Tuesday that Japan “must avoid a return to deflation”.

“No matter who becomes the new leader of the PDL and whatever faith he or she holds, we hope to communicate closely with the new government,” Ueda told a news conference.

There is also uncertainty as to whether the other leaders would support further rate hikes. Ishiba, who has been critical of the BOJ’s negative interest rate policy, recently told reporters that a complete exit from deflation is extremely important. Little is known about Koizumi’s views on monetary policy.

While a Takaichi victory could be the BOJ’s worst-case scenario, the other candidates could also reject its plans to raise rates if Japan’s economy is hit by headwinds such as an increase in yen and weak global demand, Nomura’s Kiuchi said.

“Many candidates seem to support raising interest rates because it helps slow the yen’s decline and inflation. But that could change once the economy weakens and the focus shifts to declining growth.”