Political Uncertainty in Japan’s Leadership Race

By Leika Kihara
TOKYO (Reuters) – Political uncertainty and the emergence of a candidate with a reflationist approach in Japan’s ruling party leadership race may pressure the central bank to maintain low interest rates.

The Bank of Japan (BOJ) has already moderated its signals regarding future rate hikes due to U.S. recession risks and volatile financial markets affecting the economic outlook.

As the race heats up to appoint the ruling Liberal Democratic Party’s (LDP) new leader, who will become the next prime minister, political dynamics further complicate the situation.

Key Candidate
Sanae Takaichi, a 63-year-old proponent of former premier Shinzo Abe’s “Abenomics” stimulus policies, is among the top contenders vying for a run-off position.

Initially considered a long-shot, Takaichi could become Japan’s first female leader and is a vocal critic of further interest rate hikes. “We must keep monetary policy accommodative until real wages stably turn positive,” she asserted.

Market Reactions
Polls show Takaichi, former defense minister Shigeru Ishiba, and ex-environment minister Shinjiro Koizumi as the leading candidates, though the race remains too close to call. Analysts suggest that if Takaichi wins, the immediate market reaction could lead to a decline in the yen due to anticipated delays in rate hikes.

Re-emergence of Deflation Rhetoric
Under pressure from their former leader Abe, the BOJ implemented aggressive stimulus measures in 2013 to combat low inflation, aiming for a 2% target. In March, amid rising costs and a tight labor market, the BOJ began to exit this policy.

The resignation of Prime Minister Fumio Kishida, who supported this exit strategy, poses further difficulties for the BOJ, especially if Takaichi succeeds. Analysts perceive any Takaichi victory as detrimental to the bank’s rate hiking strategy, regardless of who ultimately becomes prime minister.

Even if she doesn’t take the prime ministerial role, strong performance in the leadership race could influence the next premiership. Takaichi holds the position of economic security minister and has support from reflation-minded lawmakers and Abenomics’ architects.

Abe’s passing and an uptick in inflation temporarily shifted focus from reflationist policies; however, there remains a solid base of conservative LDP supporters favoring big spending and low rates, complicating plans to reduce heavy stimulus reliance.

Despite the BOJ’s position of independence, political discontent surrounding its policies has historically resulted in public dissatisfaction, especially as many attribute Japan’s decade-long economic stagnation to earlier tightening measures.

While the leadership votes include only LDP members, public sentiment has praised Takaichi’s economic vision, with supporters expressing optimism for Japan’s future under her potential leadership.

Addressing concerns about raising borrowing costs, BOJ Governor Ueda acknowledged the importance of avoiding a return to deflation and emphasized the need for close communication with the new government.

Uncertainty persists over whether other leading candidates would support additional rate hikes. Although Ishiba has publicly criticized the BOJ’s negative interest rate policy, Koizumi’s stance on monetary matters remains unclear. A Takaichi win could hinder the BOJ’s plans, but shifting economic conditions might likewise sway the other candidates against rate hikes as growth slows.

Conclusion
Though many candidates appear to support rate increases to balance yen fluctuations and inflation, this may evolve if the economy faces challenges. The focus could switch to prioritizing growth over inflation management.