Japan’s Central Bank to Remain Undeterred on Rate Hikes Despite LDP’s Electoral Shock

The LDP’s loss, a significant moment in Japan’s political landscape, leaves Prime Minister Shigeru Ishiba with fewer coalition options. Besides its junior partner Komeito, the LDP may need to broker additional alliances or even consider a minority government—a rare arrangement for Japan, where single-party dominance has been the rule. While the LDP’s diminished seat count presents new challenges for Ishiba’s government, experts believe these shifts will have minimal impact on the BOJ’s plans.

David Boling, director of Japan and Asian trade at Eurasia Group, framed the election loss as a blow to the LDP but not a fatal one. “The LDP got a black eye, but they’re still standing and remain the biggest party,” Boling remarked. He emphasized that the party would continue to drive coalition negotiations, likely avoiding political instability severe enough to disrupt the BOJ’s policy.

As the central bank approaches its policy decision on Thursday, most economists forecast no immediate changes. A Reuters poll revealed that 86% of economists expect the BOJ to maintain current rates, with Chief Japan Economist Izumi Devalier at Bank of America describing the chances of a hike this week as “close to zero.” However, Devalier noted that market conditions, particularly yen depreciation, could still nudge the bank toward a rate hike as early as December or January.

The yen’s ongoing weakness remains a critical pressure point for the BOJ. Japan’s currency has slid significantly against the dollar, affecting import costs and consumer purchasing power. While political instability could, theoretically, delay BOJ policy shifts, Devalier contends that Governor Kazuo Ueda and the central bank will prioritize currency stabilization over political concerns. “I don’t think the election result will keep the BOJ on hold indefinitely,” she observed, adding that market dynamics could prompt the central bank to act sooner rather than later.

Katsuhiko Aiba, Citi’s Japan economist, shared a similar view, stating that the election outcome is unlikely to derail the BOJ’s focus on hiking. Aiba flagged a potential pivot if Prime Minister Ishiba were to resign and Sanae Takaichi, a proponent of monetary easing, emerged as his successor. Takaichi, who narrowly lost the LDP’s leadership race to Ishiba, previously warned the BOJ against raising rates and would likely bring a different perspective to central bank policy.

Jesper Koll, expert director at Monex Group in Tokyo, expects the BOJ to assert its independence amid the political turbulence, arguing that Ueda has the public’s backing to pursue monetary normalization. “Yes, desperate politicians will make louder calls for BOJ action, but Ueda knows what he’s doing and has full public support,” Koll said.

Since Ueda’s appointment in April, the BOJ has taken cautious steps away from Japan’s ultra-loose monetary policy, which had been the norm for nearly a decade. The central bank has moved incrementally, aiming to address inflationary concerns while keeping debt-servicing costs manageable. With global inflation rising and Japan’s economy now facing the ripple effects of yen devaluation, a further shift is anticipated in the coming months, although it is not yet clear when that will materialize.

Political analysts suggest that the BOJ’s gradualist approach aligns with its assessment that Japan’s inflation trajectory, although rising, remains relatively moderate compared to global standards. By normalizing monetary policy without haste, the BOJ seeks to stabilize the yen and address inflation without shocking an economy that is still adjusting to post-pandemic realities.

While the central bank is taking cues from global economic indicators, its primary concerns remain domestic. For Japan, the prospect of normalizing rates after years of negative interest policy represents both a return to traditional economic fundamentals and a balancing act.