BOJ preview: interest rates to remain unchanged amid political uncertainty

Investing.com-- The Bank of Japan is expected to keep interest rates unchanged at the conclusion of a meeting on Thursday, with heightened political uncertainty in the country likely clouding the central bank’s plans to tighten monetary policy. 

The BOJ is forecast to leave its benchmark short-term rate unchanged at 0.25%, according to a Reuters poll. The central bank had hiked the rate twice so far this year, citing a virtuous cycle of higher wages and increased private spending. 

But analysts were doubtful over the BOJ’s capacity to raise interest rates further this year, especially in the face of a fractured political outlook. 

A coalition led by Japan’s ruling Liberal Democratic Party lost its parliamentary majority in elections held over the weekend. The LDP is now expected to seek alliances with smaller, regional parties to maintain power, diluting its political standing. 

Such a scenario is likely to unlock increased fiscal spending in the country, with the BOJ expected to face more political opposition in tightening monetary policy. 

The leader of Japan’s opposition party, the Democratic Party for the People, said this week that the BOJ must avoid hiking interest rates early, citing sluggish wage growth in recent months.

While increased wages had sparked some strength in private consumption and household spending earlier this year, the trend was seen slowing through September and likely October.

Japanese consumer inflation also struggled to hold above the BOJ’s 2% annual target in recent months, further complicating the central bank’s plans to tighten policy.

Governor Kazuo Ueda said last week that the BOJ was still taking time to sustainably achieve its inflation goals. But he also warned against raising interest rates too slowly. 

The BOJ is widely expected to address this trend in its Thursday rate decision. But analysts were doubtful over whether the bank will signal more rate hikes in the face of heightened political uncertainty. 

“Longer term, the BOJ is likely to remain committed to its rate normalisation plans. In the short term, it will be cautious given that political uncertainty is elevated. We do not expect the BoJ to hike rates,” analysts at ANZ wrote in a note, adding that their base case was still for a 25 basis point hike in December. 

How will the Nikkei react?

Japanese stocks were on a tear this week after the LDP’s election loss, with the Nikkei 225 and TOPIX rising sharply as expectations of more fiscal spending and delays to the BOJ’s plans presented a brighter outlook for local markets. 

Any dovish signals from the BOJ are likely to spark further gains in Japanese markets, given that despite hikes earlier this year, Japanese interest rates still remain well below those in other developed markets. 

Citi analysts wrote in a recent note that the prospect of more expansionary policies in Japan, especially on the fiscal front, heralded strength in local stocks. This trend was likely to offset most headwinds from political uncertainty.

How will USDJPY react?

The Japanese yen weakened sharply after the LDP election loss, with the USDJPY pair- which gauges the number of yen required to buy one dollar- rising to a three-month high this week.

The yen was already nursing losses through October on growing expectations that steep rate differentials between the U.S. and Japan will persist in the coming months. Any more dovish signals from the BOJ are likely to further this trend. 

UBS analysts said that political uncertainty clouded the near-term outlook for the yen. But they forecast some medium-term strength in the yen on a sustained uptrend in the Japanese economy, and an eventual decline in U.S. interest rates.