By Leika Kihara
TOKYO (Reuters) – Concerns are rising in Japan over the risk of ending up with a minority coalition government after the upcoming general election, which could complicate the central bank’s efforts to gradually reduce decades of monetary stimulus.
Recent polls have indicated the possibility of the ruling coalition losing its majority in parliament, which could lead to premier Shigeru Ishiba losing his job or the Liberal Democratic Party (LDP) needing to find an additional coalition partner to remain in power.
This scenario could hinder the Bank of Japan’s (BOJ) ability to smoothly transition away from near-zero interest rates, some analysts suggest.
It may also create market uncertainty as attention shifts to the policy stance of opposition parties that could potentially form a coalition, many of which support maintaining low interest rates.
“Many opposition and ruling parties are advocating for measures to increase wages, which could make it challenging for the BOJ to raise rates until there is more clarity on wage developments next year,” said Naoya Hasegawa, chief bond strategist at Okasan Securities.
“If the ruling coalition loses, markets will begin to factor in the possibility of significant fiscal spending and a delay in further interest rate hikes,” he added.
Anticipated delays in rate hikes could push short-term interest rates lower, making it more difficult for the BOJ to execute its plans to exit accommodative policy smoothly, analysts warn.
When Ishiba dissolved parliament on October 9 and called for a snap election on October 27, many analysts expected the ruling coalition to secure a majority, giving the new premier more flexibility in policy decisions.
This outcome would have enabled Ishiba to fulfill his promise, outlined in a book he published in August, to scale back former premier Shinzo Abe’s “Abenomics” radical stimulus measures, which included the BOJ’s ultra-easy policy.
“Extraordinary monetary policy cannot solve Japan’s problems,” Ishiba wrote in the book, attributing excessive yen depreciation, damage to commercial banks’ profits, and erosion of fiscal discipline to Abenomics and ultra-low rates.
The BOJ terminated negative interest rates in March and raised short-term rates to 0.25% in July, believing Japan was making progress towards achieving its 2% inflation target sustainably.
BOJ Governor Kazuo Ueda has indicated a willingness to continue raising rates if the economy progresses as projected.
A slight majority of economists surveyed by Reuters do not foresee a rate hike this year, with most expecting the central bank to raise rates again by March next year.
However, recent media polls have dashed hopes among policymakers that Ishiba will strengthen his position within the ruling party post-election and support the gradual exit from ultra-low interest rates.
While earlier polls predicted that the LDP and its coalition partner Komeito would maintain their majority, a recent poll by the Asahi newspaper suggested they may struggle, with the LDP potentially losing 50 of its 247 seats.
Such significant losses could make Ishiba vulnerable to criticism from supporters of aggressive monetary easing like Sanae Takaichi, whom Ishiba narrowly defeated in the party’s leadership contest.
If the LDP must seek support from opposition parties to stay in power, it will pose additional challenges to further rate hikes by increasing uncertainty regarding the new administration’s monetary policy direction.
The largest opposition party, Constitutional Democratic Party of Japan, has proposed adjusting the BOJ’s inflation target from 2% to one that “exceeds zero,” allowing for rate hikes even when inflation falls below 2%.
However, the party’s leader, Yoshihiko Noda, ruled out the possibility of forming a coalition with the LDP.
This leaves smaller opposition parties Japan Innovation Party and Democratic Party for the People as potential coalition partners.
The former aims to amend the law granting the BOJ independence in monetary policy and include maximum job creation and sustained economic growth in its mandate. The latter advocates for expansionary fiscal and monetary policies to achieve higher wage growth.
“The hurdle for additional BOJ rate hikes will increase if such proposals are considered in economic policy-making post-election,” said Yasunari Ueno, chief market economist at Mizuho Securities.
Even if the current coalition retains a majority and Ishiba remains in charge, the premier will need to address his low approval ratings, which were partly affected by his policy reversals, including on monetary policy.
The day after taking office, Ishiba surprised markets by stating that the economy was not ready for further rate hikes, a reversal from his previous support for the BOJ to unwind extreme monetary stimulus measures.
If the LDP-Komeito coalition loses its majority, the new coalition is likely to commit to significant fiscal spending supported by loose monetary policy to gain voter support ahead of next year’s upper house election, according to Takuji Aida, chief economist at Credit Agricole Securities.
“It will be nearly impossible for Ishiba to achieve his goal of transitioning to anti-Abenomics and tighter fiscal policy.”