Japan's general election outcome could muddle BOJ plans

By Leika Kihara

TOKYO (Reuters) - The risk of Japan ending up with a minority coalition government after the upcoming general election is raising concerns that the central bank could face complications in its quest to gradually wean the nation off decades of monetary stimulus.

Several recent polls have shown the possibility of the ruling coalition losing its majority in parliament, which could cost premier Shigeru Ishiba his job or force his Liberal Democratic Party (LDP) to look for an additional coalition partner to stay in power.

Such a prospect could deprive the BOJ of the political stability needed to steer a smooth lift-off from near-zero interest rates, some analysts say.

It will also cause uncertainty in markets as attention is drawn to the policy stance of opposition parties that could become a potential coalition partner, many of which favour maintaining low interest rates.

"Many opposition and ruling parties are calling for steps to boost wages, which could make it hard for the BOJ to hike rates until there is more clarity on next year's wage developments," said Naoya Hasegawa, chief bond strategist at Okasan Securities.

"If the ruling coalition loses, markets will start to price in the chance of aggressive fiscal spending and a delay in further interest rate hikes," he said.

Expectations of a rate hike delay could push down short-term interest rates, potentially making it even harder for the BOJ to smoothly execute its plans for exiting accommodative policy, analysts say.

When Ishiba dissolved parliament on Oct. 9 and called a snap election to be held on Oct. 27, many analysts expected the ruling coalition to comfortably win a majority and give the new premier a freer hand on policy.

That would have allowed Ishiba to meet his pledge, made in a book he published in August, to roll back former premier Shinzo Abe's "Abenomics" radical stimulus measures that included the BOJ's ultra-easy policy.

"Extraordinary monetary policy cannot cure Japan's ills," Ishiba wrote in the book, blaming Abenomics and ultra-low rates for causing excessive yen falls, hurting commercial banks' profits and eroding fiscal discipline.

The BOJ ended negative interest rates in March and raised short-term rates to 0.25% in July on the view Japan was making progress towards durably achieving its 2% inflation target.

BOJ Governor Kazuo Ueda has signalled readiness to keep raising rates if the economy moves in line with its projections.

A slim majority of economist polled by Reuters saw the BOJ forgoing a hike this year, with most expecting the central bank to raise rates again by March next year.

NEW COALITION RISK

Recent media polls, however, have dashed hopes among policymakers that Ishiba will solidify his standing in the ruling party after the election and support the central bank's gradual exit from ultra-low interest rates.

While earlier polls projected the LDP and its coalition partner Komeito would maintain their majority, a weekend poll by the Asahi newspaper showed they may struggle, with the LDP potentially losing 50 of the 247 seats it now has.

Such a huge loss could make Ishiba vulnerable to attack from proponents of aggressive monetary easing like Sanae Takaichi, whom Ishiba narrowly beat in the party's leadership race.

If the LDP is forced to court opposition parties to stay in power, that will increase challenges for further rate hikes by heightening uncertainty over the new administration's monetary policy stance.

The biggest opposition, Constitutional Democratic Party of Japan, has called for modifying the BOJ's inflation target from the current 2% to one "exceeding zero" - a move that will leave scope for rate hikes even when inflation slides below 2%.

But the party's leader, Yoshihiko Noda, has ruled out the chance of forming a coalition with the LDP.

That leaves smaller opposition parties Japan Innovation Party and Democratic Party for the People, as potential coalition partners.

The former wants to revise the law giving BOJ independence over monetary policy, and add maximum job creation and sustained economic growth to its mandate. The latter favours expansionary fiscal and monetary policies to achieve higher wage growth.

"The hurdle for additional BOJ rate hikes will heighten if such proposals are taken into account in economic policy-making after the election," said Yasunari Ueno, chief market economist at Mizuho Securities.

Even if the current coalition retains a majority and keeps Ishiba at the helm, the premier will face the challenge of pushing up his low approval ratings which partly took a hit with his flip-flop on topics including monetary policy.

A day after becoming premier, Ishiba stunned markets by saying the economy was not ready for further rate hikes, an apparent about-face from his previous support for the BOJ unwinding decades of extreme monetary stimulus.

If the LDP-Komeito coalition loses a majority, the newly created coalition will likely be forced to pledge big fiscal spending backed by ultra-loose monetary policy to appease voters ahead of next year's upper house election, said Takuji Aida, chief economist at Credit Agricole Securities.

"It will become nearly impossible for Ishiba to fulfil his goal of shifting to anti-Abenomics, tighter fiscal policy."

(Reporting by Leika Kihara; Editing by Shri Navaratnam)