The shadow of Abenomics looms, is the Bank of Japan still hopeless to raise interest rates?

The Bank of Japan faces potential political pressure to continue raising interest rates.

On Friday, September 27th, Japan will hold the Liberal Democratic Party (LDP) leadership election, and the winner will become Japan's next prime minister. According to surveys of Japanese parliamentarians, LDP members, and party supporters, Sanae Takaichi is one of the three main candidates and could become Japan's first female prime minister.

As an advocate of "Abenomics," Sanae Takaichi advocates against further interest rate hikes. If elected, she may put pressure on the Bank of Japan to slow down the pace of rate hikes.

The uncertainty of political factors adds complexity to the Bank of Japan's interest rate hikes. At the same time, with increasing risks of economic recession in the United States and turmoil in global financial markets, the Bank of Japan's hawkish stance has weakened.

Sanae Takaichi: Advocate of "Abenomics"

In 2013, under pressure from then-Prime Minister Shinzo Abe, the Bank of Japan introduced aggressive stimulus policies, which later evolved into a complex policy mix aimed at pushing weak inflation towards the 2% target.

With rising raw material costs and a tight job market driving up inflation and wages, the Bank of Japan ended this policy mix in March of this year. In July, under the leadership of Governor Haruhiko Kuroda, the Bank of Japan raised interest rates to 0.25%.

At 63, Sanae Takaichi currently serves as the Minister of Economic Security, and is one of the advocates of the "Abenomics" stimulus policies, and the only candidate who explicitly opposes further rate hikes.

On September 23rd, Sanae Takaichi stated during a live broadcast that "raising rates now is foolish," warning that doing so could push Japan back into deflation. On the 19th, she said in an interview:

"What we are seeing now is cost-push inflation. We must maintain loose monetary policy until real wages stabilize."

Sanae Takaichi's economic plan has garnered support from some legislators and scholars, such as former Abe economic advisor Etsuro Honda, who played a key role in Abenomics, supporting reflation to counter deflationary pressures.

Since Abe's assassination in 2022, the resurgence of inflation in Japan has pushed reflation to the background, but among conservative LDP supporters, large-scale spending and ultra-low interest rates remain popular. In addition, many people are dissatisfied with the Bank of Japan's policies, attributing the decade-long economic stagnation since the late 1990s to the Bank of Japan's premature tightening policies.

Obstacles to the Bank of Japan's Interest Rate Hikes

Sanae Takaichi's dovish remarks have raised concerns in the market that if she takes office, the Bank of Japan's interest rate hikes may face obstacles. Naoshi Murama, Chief Bond Strategist at Mitsubishi UFJ Morgan Stanley, said:

"If Sanae Takaichi wins, the initial market reaction may be a decline in the yen, as the market will consider that the Bank of Japan's future rate hikes may be delayed."

Even if Sanae Takaichi does not become prime minister, analysts believe that her outstanding performance in the election may still help her secure a key cabinet position and exert pressure on the next prime minister Kuruma Naomi also pointed out that it is uncertain whether other leading candidates would support further rate hikes. Shigeru Ishiba, who has criticized the Bank of Japan's negative interest rate policy, recently told Reuters that completely escaping deflation is crucial. Therefore, while a victory for Sanae Takaichi may be the worst-case scenario for the Bank of Japan, other candidates may also oppose the central bank's rate hike plans as Japan's economy faces headwinds such as a soaring yen and weak global demand. Kuruma Naomi said:

"Many candidates seem to support rate hikes because it helps to slow down the depreciation of the yen and inflation. However, once the Japanese economy weakens and economic growth slows down, this situation may change."

Some analysts believe that the resignation of current Prime Minister Fumio Kishida is a blow to the Bank of Japan, as Kishida appointed Haruhiko Kuroda as the central bank governor and supported the gradual tightening of monetary policy by the Bank of Japan. Norinchukin Research Institute economist and Bank of Japan director Takanobu Kiuchi stated:

"Regardless of who wins the LDP election, the situation will not be better for the Bank of Japan than when Fumio Kishida was prime minister. If Sanae Takaichi wins, the Bank of Japan will find it difficult to raise interest rates."

Haruhiko Kuroda stated at a press conference on Tuesday that Japan "must avoid a return to deflation," and he also mentioned:

"Regardless of who becomes the new leader of the LDP, no matter what their beliefs are, we hope to have close communication with the new government."

Kuroda reiterated the Bank of Japan's position that the central bank will raise rates again if the data supports it, but will not rush to do so. Some analysts believe that his remarks indicate a low likelihood of policy action by the Bank of Japan at the meeting next month