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Japan Likely to Continue Rate Hikes Despite Prime Minister Ishiba’s Dovish Comments

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Following dovish remarks by Japanese Prime Minister Shigeru Ishiba, the yen plummeted sharply to 147.15 against the U.S. dollar, marking its steepest decline since June 2022. Despite this, market analysts maintain their expectations that the Bank of Japan (BOJ) will proceed with rate hikes in the longer term.

Prime Minister Ishiba, in a significant shift from his campaign rhetoric, stated, “I do not believe that we are in an environment that would require us to raise interest rates further,” after meeting with BOJ Governor Kazuo Ueda. Ishiba’s softer stance was surprising, given his past criticism of Abenomics, the aggressive monetary easing strategy promoted by the late Prime Minister Abe Shinzo.

However, economists like Stefan Angrick from Moody’s Analytics remain confident that the BOJ will hike rates again soon, citing optimistic economic outlooks from the September meeting minutes. Despite Ishiba’s comments, Angrick told CNBC, “My money is still on a rate hike in October.”

Bank of Japan’s Next Steps

The BOJ, which raised its benchmark interest rate to “around 0.25%” in September, its highest since 2008, is scheduled to review rates again on October 30-31. Although the futures market showed less than a 50% chance of a rate increase by year-end, expectations for further tightening remain strong among analysts.

Asahi Noguchi, a BOJ board member, stated that the central bank should maintain its accommodative policy in the near term, emphasizing the need to change public perceptions about future price increases.

Economic Context and Yen Weakness

Japan’s economy and inflation have developed largely in line with the BOJ’s expectations, but the yen’s persistent weakness complicates matters. Analysts are focused on how exchange rates, particularly the yen’s value against the dollar, will influence future BOJ decisions. Higher interest rates generally support a stronger yen, which can hurt Japanese exporters by making their goods more expensive globally.

The yen carry trade, in which investors borrow in low-interest yen and invest in higher-yielding currencies, has been a key factor driving currency volatility. When the BOJ raised rates in July, it triggered an unwinding of the carry trade, leading to a significant sell-off in global markets.

Ken Matsumoto of Crédit Agricole CIB suggested that a BOJ rate hike could happen as early as the January 2024 meeting, but noted that the upcoming General Election on October 27 could disrupt this timeline. A decision on further hikes may depend on the outcome of the election and its impact on fiscal policy.

Long-Term Outlook and Potential Delays

Some experts, like Mazen Issa of MRB Partners, are cautious about the exact timing of the next BOJ hike but agree that additional tightening is on the horizon. Issa remarked, “We would not rule out another rate hike by the end of this year, but if not, the BOJ will hike by early 2025.”

Nomura’s Yujiro Goto echoed a similar sentiment, suggesting that a December rate hike is still possible under certain conditions, including yen depreciation, a stable U.S. economy, and an avoidance of a hard landing in the U.S.

Fundamentally, Japan’s economic outlook remains tied to global conditions, particularly in the U.S. If the yen remains stable or strengthens, experts like Kazuo Momma from Mizuho believe that the BOJ could delay further rate increases until at least January 2025.

While Prime Minister Ishiba’s comments have shifted market expectations in the short term, the BOJ is still widely expected to stick to its long-term hiking cycle to address inflation and stabilize the yen. The timeline may vary depending on domestic political developments and the broader international economic environment.

 

Japan’s New Prime Minister Faces Uncertain Path as Political Outsider

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Shigeru Ishiba, set to become Japan’s next prime minister, has long been known for his dissent from party orthodoxy, particularly as a critic of former Prime Minister Shinzo Abe’s economic policies. Despite his outsider status and differing views, experts question whether Ishiba will be able to govern in line with his past stances, especially in the face of entrenched party dynamics.

Ishiba, who won his fifth attempt to lead the ruling Liberal Democratic Party (LDP), has consistently opposed Abe’s “Abenomics,” which promoted loose monetary policies and economic stimulus. Instead, Ishiba has advocated for fiscal tightening and tax increases, opposing the Bank of Japan’s (BOJ) policy of negative interest rates. His victory in the recent runoff against Sanae Takaichi, a proponent of Abenomics, marks a shift in party leadership, but analysts are uncertain whether it will lead to significant policy changes.

Experts like Tobias Harris, founder of Japan Foresight, emphasize that Abe’s legacy remains influential, making it difficult for any new leader to break away from his policies. The central question is whether Japan is ready to “course correct” from Abenomics. Sayuri Shirai, an economist and professor at Keio University, believes Ishiba represents a fresh perspective but warns that his ability to implement outsider policies remains unclear.

Shortly after his election, Ishiba hinted at maintaining an accommodative monetary stance, signaling a potential softening of his previous views on interest rate hikes. His approach seems to align more closely with outgoing Prime Minister Fumio Kishida’s policies, which have focused on pulling Japan out of prolonged deflation. While Japan reported a 3% inflation rate in August, the country’s struggles with low domestic demand continue to weigh heavily on economic decision-making.

Japan’s stock markets reacted negatively to the leadership change, with the Nikkei 225 index logging its worst day since 1987 following the BOJ’s rate hike in July. Market experts have warned that economic uncertainty could complicate Ishiba’s plans for raising interest rates. According to a recent BOJ meeting summary, financial instability may delay further hikes, a view echoed by analysts like Steven Glass of Pella Funds, who argues that Japan’s current economic conditions do not support higher rates.

In addition to monetary policy challenges, Ishiba’s fiscal proposals, which aim to reduce Japan’s budget deficit and provide more support to rural and younger communities, may face resistance. Tax increases, a central part of his fiscal plan, are likely to be unpopular among certain factions within the LDP and broader Japanese society. Previous leaders, including Kishida, have backtracked on similar proposals due to market backlash and political opposition.

Political analysts, like Mio Kato of LightStream Research, caution that individual leaders in Japan’s LDP often struggle to significantly alter the party’s overall direction. Ishiba, despite his history of dissent, may be constrained by the same forces. Keio University’s Shirai notes that Ishiba will need to “sell” potentially unpopular policies, such as tax hikes, to the public, which remains a significant challenge.

Ultimately, Japan Foresight’s Harris remains skeptical that Japan is ready to fully abandon aspects of Abenomics, such as fiscal spending aimed at growing the economy. He argues that there is little appetite for drastic spending cuts or tax increases, suggesting that Ishiba may have to navigate carefully within the bounds of existing economic strategies, despite his critical stance on the policies of the past.