By Leika Kihara

TOKYO (Reuters) – Bank of Japan Governor Kazuo Ueda’s efforts to lift rock-bottom borrowing costs face new challenges as a yen rebound and the new political leadership’s preference for loose monetary policy raise the hurdle for rate hikes.

New Japanese premier Shigeru Ishiba stunned markets this week when he stated the economy was not ready for further rate hikes, a shift from his prior support for the BOJ’s exit from decades of extreme monetary stimulus.

The blunt remarks pushed the yen lower against the dollar and created new doubts about the BOJ’s willingness to raise rates aggressively.

While politics is unlikely to completely derail the long-term case for rate hikes, analysts expect bumpy policy deliberations leading up to the general election due on Oct. 27.

“I don’t think the remarks were intended to apply huge pressure on the BOJ. Rather, Ishiba probably had the election in mind,” said Katsuhiro Oshima, chief economist at Mitsubishi UFJ Morgan Stanley Securities. “He was perceived by markets as a hawk, so may have wanted to fine-tune that image a little bit.”

The looming election this month leads many analysts to believe the BOJ will refrain from raising rates at its meeting on Oct. 30-31.

Ueda was appointed last year by former Prime Minister Fumio Kishida, who endorsed the BOJ’s exit from radical monetary stimulus before stepping down in September.

In March, the BOJ delivered its first rate hike in 17 years, arguing that the pace of price and wage increases indicated Japan was breaking out of its entrenched deflationary mindset.

However, this bold shift to a tightening bias met resistance this week, with Ishiba’s new cabinet reaffirming a 2013 commitment with the BOJ to focus on reflating the stagnant economy.

To be sure, pressure on the BOJ to raise rates immediately this year was already easing before Ishiba took office, partially due to a rebound in the yen, which moderated inflationary pressure from import costs.

Anticipating political turbulence, the BOJ has prepared to pause its rate hikes. Following a steady rate last month, Ueda indicated there is no rush to hike in light of unstable markets and increasing U.S. economic uncertainties.

“They won’t directly affect monetary policy,” said a source familiar with the BOJ’s thinking regarding Ishiba’s statements. “But there’s also no necessity for the BOJ to hike rates when there are so many external factors at play.”

POLITICAL UNCERTAINTY MAY CONTINUE

Following its end of negative interest rates in March and another rate hike in July, Ueda remarked that the BOJ would continue to raise rates to a level that neither cools nor overheats growth – estimated by analysts to be around 1-1.5% if the economy aligns with forecasts.

With inflation surpassing 2% for over two years and a tight labor market driving wage increases, a prolonged pause could complicate communication of the BOJ’s intent.

However, political uncertainties heading into the election could prompt the BOJ to leverage overseas risks, such as a slowing U.S. economy, as reasoning to postpone rate increases.

This messaging strategy could help alleviate market concerns that the BOJ is completely abandoning its tightening bias.

“It’s essential for the BOJ to improve its communication to avoid unnecessary confusion over its policy shift,” BOJ board member Asahi Noguchi stated on Thursday, acknowledging communication challenges with markets.

Uncertainty also surrounds whether Ishiba would again endorse a BOJ exit once the election concludes, a move many policymakers and analysts anticipate.

Polls indicated Ishiba’s approval ratings at 50.7% during a Kyodo news agency survey conducted on Oct. 1-2, lower than the debut ratings of previous administrations, hinting at a tough electoral battle.

While Ishiba’s Liberal Democratic Party (LDP) is poised to remain in power, a significant loss of seats could undermine his position within the party, compelling him to respond to demands for loose fiscal and monetary policy, analysts warn.

Political uncertainty may persist depending on the outcome of this month’s lower house election and the subsequent upper house elections expected next summer.

“If Ishiba secures a solid victory at this month’s election and stabilizes the political landscape, the BOJ could consider raising rates in December or January,” said Shigeto Nagai, head of Japan economics at Oxford Economics.

“If political instability continues, it could undermine the BOJ’s strategy to lift rates close to 0.75% next year,” he added. “In essence, the BOJ likely desires to move swiftly.”