How Japan's Election Outcome Poses Risks for BOJ Policy

TOKYO: Japan's upcoming general election raises concerns about the possibility of a minority coalition government, which could complicate the central bank's efforts to gradually reduce long-standing monetary stimulus. Recent polls indicate that the ruling coalition may lose its majority in parliament, potentially jeopardizing Premier Shigeru Ishiba's position and forcing his Liberal Democratic Party (LDP) to seek additional coalition partners.

This scenario could hinder the Bank of Japan (BOJ) from achieving the political stability necessary for a smooth transition from near-zero interest rates, according to analysts. The potential shift in power could also create market uncertainty as attention turns to the policy positions of opposition parties that may become coalition partners, many of which advocate for maintaining low interest rates.

"Many opposition and ruling parties are calling for steps to boost wages, which could make it challenging for the BOJ to raise rates until there is more clarity on wage developments for next year," analysts noted. "If the ruling coalition loses, markets may anticipate aggressive fiscal spending and delays in interest rate hikes."

Concerns about a delay in rate increases could lead to a decline in short-term interest rates, complicating the BOJ's plans to exit its accommodative policy. When Ishiba dissolved parliament on October 9 and announced a snap election for October 27, many analysts predicted a comfortable win for the ruling coalition, allowing the new premier greater freedom in policymaking.

Ishiba had pledged to roll back the "Abenomics" stimulus measures initiated by former Premier Shinzo Abe, which included the BOJ's ultra-easy policy. In a book published in August, Ishiba argued, "Extraordinary monetary policy cannot cure Japan's ills," blaming Abenomics for adverse effects like excessive yen depreciation and reduced bank profits.

The BOJ ended its negative interest rate policy in March and raised short-term rates to 0.25% in July, signaling progress towards achieving a sustainable 2% inflation target. BOJ Governor Kazuo Ueda has indicated a willingness to continue rate hikes if economic conditions align with projections.

Despite this, recent polls have dampened hopes that Ishiba can solidify his influence within the ruling party post-election, potentially challenging the central bank's gradual exit from low rates. A recent poll by the Asahi newspaper suggested that the LDP may lose up to 50 of its 247 seats, creating vulnerabilities for Ishiba and increasing the likelihood of pressure from advocates of more aggressive monetary easing.

If the LDP must collaborate with opposition parties to retain power, this could lead to further uncertainties regarding the new government's monetary policy. The largest opposition party, the Constitutional Democratic Party of Japan, has proposed altering the BOJ's inflation target from the current 2% to "exceeding zero," which would allow for rate hikes even if inflation drops below 2%. However, party leader Yoshihiko Noda has ruled out forming a coalition with the LDP.

This leaves smaller opposition groups like the Japan Innovation Party and the Democratic Party for the People as potential partners. The Japan Innovation Party seeks to revise laws governing the BOJ's independence and expand its mandate to include job creation and sustainable economic growth, while the Democratic Party for the People advocates for expansionary fiscal and monetary policies to boost wage growth.

Even if the current coalition retains its majority and Ishiba continues as premier, he will face the challenge of improving his low approval ratings, which have suffered due to his inconsistent stance on monetary policy. Just a day after taking office, Ishiba surprised markets by stating that the economy was not ready for further rate hikes, contradicting his previous support for the BOJ's exit from extreme monetary stimulus.

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