Analysis-Result of Japan's general election could mess up BOJ's plans By Reuters

Written by Leika Kihara

TOKYO (Reuters) – The risk that Japan will end up with a coalition government after a general election is raising concerns that the central bank could face problems in its bid to gradually wean the nation out of decades of monetary stimulus.

Several recent polls have shown the coalition may lose its majority in parliament, which could cost Prime Minister Shigeru Ishiba his job or force the Liberal Democratic Party (LDP) to look to another coalition partner to stay in power.

Such optimism could rob the BOJ of the political stability it needs to avoid a smooth hike to near-zero interest rates, some analysts say.

It will also cause uncertainty in the markets as the policy stance of the potential opposition parties, most of which are in favor of keeping interest rates low, will be scrutinized.

“Many opposition parties and ruling parties want measures to be taken to raise wages, making it difficult for the BOJ to raise rates until there is more clarity on wage developments for next year,” said Naoya Hasegawa, chief bond strategist at Okasan Securities.

“If the ruling coalition loses, the markets will start to fall in price on the possibility of aggressive monetary spending and the delay of further interest rate hikes,” he said.

Expectations of a delayed rate hike could lower short-term interest rates, potentially making it more difficult for the BOJ to successfully implement its plans for a policy exit, analysts said.

When Ishiba dissolved parliament on October 9 and called snap elections to be held on October 27, many analysts expected the ruling coalition to win a comfortable majority and give the new prime minister a free hand on policy.

That would allow Ishiba to make good on his promise, which he made in a book he published in August, to roll back former prime minister Shinzo Abe's “Abenomics” stimulus measures that include the BOJ's ultra-easy policy.

“Absolute monetary policy cannot cure Japan's ills,” Ishiba wrote in the letter, blaming Abenomics and ultra-low rates for causing the yen to fall excessively, hurting the profitability of commercial banks and ending monetary discipline.

The BOJ ended negative interest rates in March and raised short-term rates to 0.25% in July on the assumption that Japan was making progress toward achieving its 2% inflation target.

BOJ Governor Kazuo Ueda has indicated that he is ready to continue raising rates if the economy moves in line with his projections.

A small majority of economists polled by Reuters saw the BOJ forgoing a rate hike this year, with most expecting the central bank to raise rates again in March next year.

NEW COALITION RISK

Recent media polls, however, have dashed hopes among policymakers that Ishiba will strengthen his position in the ruling party after the election and support the central bank's gradual exit from ultra-low interest rates.

While previous polls had expected the LDP and its Komeito coalition to retain their majority, a weekend poll by the Asahi newspaper showed they may struggle, with the LDP likely to lose 50 of its current 247 seats.

Such a loss would leave Ishiba vulnerable to attacks from aggressive austerity advocates such as Sanae Takaichi, whom Ishiba narrowly beat in the party leadership race.

If the LDP is forced to pay the opposition parties to stay in power, it will increase the challenges of inflation by increasing uncertainty about the stance of the new administration's monetary policy.

The main opposition party, Japan's Constitutional Democratic Party, has called for the BOJ's inflation target to be changed from the current 2% to one “beyond zero” – a move that would leave room for rate hikes even when inflation falls below 2%.

But the party's leader, Yoshihiko Noda, rejected the opportunity to form an alliance with the LDP.

That leaves the small opposition parties Japan Innovation Party and the Democratic Party for the People, as potential coalition partners.

The first seeks to revise the law that gives the BOJ freedom over monetary policy, and add job creation and sustained economic growth to its mandate. The latter allows for expansionary fiscal and monetary policies to achieve higher wage growth.

“The barrier to a BOJ rate hike will increase if these proposals are considered in economic policymaking after the election,” said Yasunari Ueno, chief economist at Mizuho Securities.

Even if the current coalition maintains a majority and keeps Ishiba in power, the prime minister will face the challenge of raising his low approval ratings that have had a major impact on his response on topics including fiscal policy.

A day after becoming prime minister, Ishiba surprised markets by saying the economy was not yet ready for more rate hikes, apparently countering his previous support for the BOJ ending decades of extreme monetary stimulus.

If the LDP-Komeito coalition loses its majority, the newly formed coalition will be forced to pledge to spend more money backed by a looser fiscal policy to appease voters ahead of next year's upper house elections, said Takuji Aida, an economist at Credit Agricole. (OTC:) Securities.

“It will be almost impossible for Ishiba to achieve his goal of switching to an anti-Abenomics, tight monetary policy.”