BOJ Confronts New Challenges as Politics and Yen Complicate Rate Hikes, Reports Reuters

By Leika Kihara

TOKYO (Reuters) – Bank of Japan Governor Kazuo Ueda’s plans to raise ultra-low borrowing costs are encountering new hurdles as the yen strengthens and the new political leadership shows a preference for maintaining loose monetary policy.

This week, Japan’s new premier, Shigeru Ishiba, surprised financial markets by stating that the economy is not prepared for further rate increases, marking a shift from his earlier support for the BOJ’s withdrawal from extensive monetary stimulus.

Ishiba’s candid comments contributed to a decline in the yen against the dollar and raised questions about the BOJ’s willingness to pursue aggressive rate hikes.

Analysts suggest that while political factors may not derail the long-term case for rate increases, discussions around policy may become turbulent as the general election approaches on October 27.

"I don’t think his comments were meant to put significant pressure on the BOJ. Rather, Ishiba likely had the upcoming election in mind," said Katsuhiro Oshima, chief economist at Mitsubishi UFJ Morgan Stanley Securities. "He was previously viewed as a hawk in the market, so he may have wanted to adjust that image somewhat."

Given the impending election, many analysts predict that the BOJ will refrain from raising rates at its meeting scheduled for October 30-31.

Ueda was appointed last year by former Prime Minister Fumio Kishida, who stepped down in September and had supported the BOJ’s movement away from its radical monetary stimulus policies.

In March, the BOJ enacted its first rate hike in 17 years, citing rising prices and wages as indicators that Japan was overcoming its long-standing deflationary mindset.

However, the recent comments from Ishiba’s cabinet have created complications for the BOJ, reaffirming a 2013 commitment for both the government and the central bank to prioritize reflating a sluggish economy.

The pressure to raise rates had already begun to ease before Ishiba took office, partly due to a rebound in the yen from a three-decade low reached in July, which alleviates inflationary pressures associated with import costs.

In light of the political landscape, the BOJ appears to be preparing for a pause in rate hikes. After keeping rates steady last month, Ueda indicated that the BOJ is not rushing to increase rates given current market instability and uncertainties in the U.S. economy.

"Ishiba’s statements won’t directly impact monetary policy," a source familiar with the BOJ’s perspective noted. "However, with various developments ongoing, the BOJ doesn’t need to rush into rate hikes."

CONTINUED POLITICAL UNCERTAINTY

Since ending negative interest rates in March and raising them again in July, Ueda has indicated that the BOJ aims to gradually increase rates without stifling growth, with an optimal range suggested to be around 1-1.5%, contingent on economic performance.

With inflation consistently above 2% for over two years and a tight labor market driving wages up, postponing actions for too long may lead to communication challenges.

However, the potential for political surprises leading up to the election might prompt the BOJ to cite external risks, such as a slowing U.S. economy, as justification for hesitating on rate hikes.

Such a strategy could help mitigate any harsh perceptions in the market about the BOJ’s commitment to tightening policy.

"It’s crucial for the BOJ to improve its communication strategies to prevent unnecessary confusion regarding its policy direction," said BOJ board member Asahi Noguchi, acknowledging communication issues between the central bank and the markets.

Uncertainty also looms regarding whether Ishiba will revert to his support for the BOJ’s exit from its previous policies post-election, which many analysts and policymakers anticipate.

Ishiba’s approval ratings were reported at 50.7% in a recent poll, which is lower than the debut ratings of his three immediate predecessors, indicating a challenging political landscape ahead.

While Ishiba’s party is expected to maintain power, analysts suggest that a significant loss of seats could weaken his position within the party, intensifying pressures to adopt looser fiscal and monetary policies.

Depending on the outcomes of this month’s lower house election, political uncertainty may persist until the upper house elections scheduled for summer next year.

"If Ishiba secures a solid victory in this month’s election and the political landscape stabilizes, the BOJ could look to raise rates in December or January," said Shigeto Nagai, head of Japan economics at Oxford Economics. "Conversely, prolonged political turmoil could jeopardize the BOJ’s strategy to reach around a 0.75% rate by next year," he added. "Ultimately, the BOJ likely desires to act promptly."