Investing.com — The Bank of Japan is expected to keep interest rates on hold at the end of Thursday’s meeting, but rising domestic political uncertainty is likely to overshadow the central bank’s monetary tightening plans.
According to a Reuters poll, the Bank of Japan is expected to keep its policy interest rate unchanged at 0.25%. The central bank has raised interest rates twice so far this year, citing a virtuous cycle of rising wages and increased consumer spending.
But analysts doubt the Bank of Japan’s ability to raise interest rates further this year, especially in the face of a fractured political outlook.
The coalition government led by Japan’s ruling Liberal Democratic Party lost its parliamentary majority in elections held over the weekend. The Liberal Democratic Party is now expected to weaken its political position, seeking alliances with smaller regional parties to maintain its hold on power.
If such a scenario were to materialize, the country would likely be able to increase fiscal spending, and the Bank of Japan would likely face political opposition to tightening monetary policy.
The leader of Japan’s opposition Democratic Party of Japan said this week that the Bank of Japan should avoid raising interest rates too early, citing slowing wage growth in recent months.
Personal consumption and household spending showed some strength earlier this year due to higher wages, but that trend is expected to slow into September and possibly October.
Japan has also struggled in recent months to beat the Bank of Japan’s 2% annual target, further complicating the central bank’s plans to tighten policy.
Governor Kazuo Ueda said last week that the Bank of Japan still has some time to reach its inflation target sustainably. However, he also warned against raising interest rates too slowly.
The Bank of Japan is widely expected to address this trend in its interest rate decision on Thursday. But analysts were skeptical whether the central bank would signal further rate hikes in the face of growing political uncertainty.
“In the longer term, the Bank of Japan is likely to remain committed to its interest rate normalization plan; it will be cautious in the short term given heightened political uncertainty,” ANZ analysts said. “We do not expect the Bank of Japan to raise interest rates,” he wrote in a note, adding that the base case remains a 25 basis point rate hike in December.
How will the Nikkei Shimbun react?
Japanese stocks tumbled this week following the Liberal Democratic Party’s election defeat, but they soared as expectations for more fiscal spending and delays in the Bank of Japan’s plans brought a brighter outlook to the domestic market.
A dovish signal from the Bank of Japan will trigger further gains in Japanese markets, given that Japanese interest rates remain well below other developed markets despite rate hikes earlier this year. Very likely.
Citi analysts wrote in a recent note that the prospect of further expansionary policy in Japan, particularly on the fiscal front, portends strength for domestic equities. This trend could offset most of the headwinds from political uncertainty.
How will USDJPY react?
The Japanese yen, which measures the number of yen needed to buy one dollar, fell sharply after the Liberal Democratic Party’s election defeat, rising to a three-month high this week.
The yen had already been depreciating until October, as there was a growing expectation that the sharp interest rate differential between Japan and the United States would continue for several months. Further dovish signals from the Bank of Japan are likely to further advance this trend.
Analysts at UBS said political uncertainty clouded the yen’s near-term outlook. However, they expect the yen to appreciate to some extent in the medium term due to the continued upward trend in Japan’s economy and ultimately lower US interest rates.
