Explainer: How Would Japan’s Ruling Party Race Impact BOJ Rate Hike Timing?

By Leika Kihara

TOKYO – The upcoming leadership election within Japan’s ruling party, set for September 27, is poised to impact the central bank’s strategy to normalize its extremely loose monetary policy.

Here are key insights into how the results of the race could influence the timing and extent of future interest rate hikes by the Bank of Japan (BOJ).

WHO ARE THE FRONT-RUNNERS?

Among the nine candidates in the race, three are identified as frontrunners likely to compete in a runoff: former defense minister Shigeru Ishiba, former environment minister Shinjiro Koizumi, and Sanae Takaichi, the minister responsible for economic security.

WHAT ARE THEIR VIEWS ON MONETARY POLICY?

Most candidates, including Ishiba and Koizumi, seem to support the idea of gradual interest rate increases.

Koizumi has stated his commitment to respecting the BOJ’s independence in setting monetary policy. Ishiba agrees that the BOJ is on the correct path by ending negative interest rates, although he emphasizes that Japan should prioritize a complete exit from deflation.

Takaichi, however, is the most outspoken critic of normalizing policy, arguing that the BOJ raised rates prematurely and that low borrowing costs are essential for maintaining consumer confidence.

HOW COULD THE RACE OUTCOME AFFECT BOJ POLICY AND MARKETS?

If Takaichi becomes prime minister or holds a significant role, such as finance minister, her preference for low borrowing costs might force the BOJ to delay rate hikes. This scenario could lead to dropping bond yields and a weakened yen, which would be contrary to policymakers’ desires for market alignment with plans to end loose monetary conditions. Conversely, bond yields could increase in the long term if Takaichi commits to a substantial spending package that may necessitate greater debt issuance.

Takaichi has called for "strategic" spending, although she has not provided specific details. Koizumi has also promised emergency financial assistance to small businesses and low-income households affected by rising living costs, but he has not outlined the proposed spending’s magnitude or funding sources. Ishiba, known for his fiscal conservatism, has advocated for improving Japan’s financial standing.

HOW WOULD THE POLITICAL CALENDAR AFFECT BOJ POLICY?

The winner of the Liberal Democratic Party’s (LDP) leadership contest is likely to become the next prime minister, thanks to the party’s strong parliamentary presence, and may call for a snap election potentially scheduled for October 27.

To avoid political complications, the BOJ might choose not to raise rates around the election timeframe, suggesting that policymakers could wait until at least December for another increase.

The central bank, which held interest rates steady in September, is set for a policy review on October 30-31, during which it will release new quarterly growth and price forecasts.

A majority of economists surveyed anticipate the BOJ will raise rates again this year following an unexpected increase in July, with over three-quarters predicting a hike during the December 18-19 meeting.