The Bank of Japan is deeply trapped in the "post-election syndrome": political deadlock vs. high inflation, with political shackles constraining the path to interest rate hikes

According to Zhitong Finance APP, the results of the Japanese election may put the Bank of Japan in a dilemma: expectations of large-scale fiscal spending may keep inflation high, while political deadlock and the lingering clouds of global trade wars may force it to slow down interest rate hikes. Some analysts point out that persistent political uncertainty may weaken the yen's exchange rate, raise import costs, and further exacerbate price pressures, which conflicts with the Bank of Japan's current stance of "waiting for political turmoil to settle before taking action."

The rising cost of living is one of the reasons for the crushing defeat of the ruling coalition led by Prime Minister Shigeru Ishiba in last Sunday's Senate election. Currently, Japan's inflation rate has been above the central bank's target of 2% for more than three consecutive years, and some members of the central bank's policy committee have issued warnings about the escalating price pressures.

Recently, Bank of Japan policy committee member Junko Koeda suggested that attention should be paid to the second-round inflation effects triggered by rising rice prices. Another member, Hajime Takata, stated this month that Japan is close to achieving the 2% inflation target, and the Bank of Japan must restart interest rate hikes after a brief pause.

"If the risks of rising inflation increase, the Bank of Japan, as the guardian of price stability, may need to take decisive action," hawkish policymaker Naoki Tamura said at the end of last month.

Now, Shigeru Ishiba's ruling camp has become a minority in both houses of parliament and must compromise with opposition parties calling for tax cuts and increased spending to pass legislation. In response to these demands, Ishiba stated on Monday that he would remain as Prime Minister and work with other parties to formulate measures to alleviate the impact of inflation on Japanese households.

Although lowering the consumption tax would create a significant gap in Japan's already deteriorating fiscal situation, this move requires parliamentary legislation and will take a long time. Analysts believe that a more likely approach is for Japan to draft an additional budget in the fall to fund subsidies and tax reductions. Given the growing calls from opposition parties for bolder measures, the budget size may exceed last year's 14 trillion yen (approximately 95 billion USD) economic stimulus plan.

"Even before the election, the market anticipated that a supplementary budget would be introduced this fall to help businesses cope with U.S. tariffs. Now, the opposition may demand a larger-scale stimulus plan," said David Boling, a director at Eurasia Group.

Yen Movement Becomes Key

Indeed, Japan's economy may need fiscal stimulus, as quarterly economic contraction has occurred, and U.S. tariffs have impacted its pillar industry, the automotive sector, with further economic pressure expected. However, analysts say that concerns about Japan's massive debt and political instability may weaken the yen and raise doubts about the Bank of Japan's view that "cost-push inflation pressures will ease later this year."

"Although Ishiba has stated he will remain as Prime Minister, the market is currently in a wait-and-see mode. But this does not mean that the possibility of a yen decline has disappeared, as the election has undoubtedly weakened the government's position," said Tsuyoshi Ueno, an economist at Japan Life Insurance Institute.

Unlike other major economies, due to the slow pace of the Bank of Japan's exit from a decade-long large-scale stimulus policy, Japan's real interest rates adjusted for inflation remain deeply negative. After raising short-term rates to 0.5% in January, Bank of Japan Governor Kazuo Ueda has indicated that interest rate hikes will be paused until the impact of U.S. tariffs on the economy is clear Given the risks posed by U.S. tariffs, most analysts expect no interest rate hikes for the remainder of the year. However, internal estimates from the central bank indicate that the policy rate needs to rise to at least 1% to reach a neutral level that neither stimulates nor suppresses growth.

Some analysts believe that if the yen depreciates again, it could become a key factor driving further interest rate hikes.

Although the law guarantees the independence of the Bank of Japan from government intervention, it has historically been quite sensitive to political dynamics. In 2013, under intense pressure from then-Prime Minister Shinzo Abe, the central bank launched a massive stimulus policy to reverse the yen's strength and combat deflation. Last year, the Bank of Japan exited its ultra-loose monetary policy due to politicians calling for measures to curb the yen's sharp decline, which had led to soaring import costs.

"For the Bank of Japan, the biggest concern is how the election results might change the government's economic policy focus and how the market will react," said a source familiar with the central bank's thinking.

Mari Iwashita, a senior observer of the Bank of Japan and head of interest rate strategy at Nomura Securities, believes that if the yen exchange rate falls below 150 yen to 1 dollar (currently around 147 yen) and pushes up prices, a rate hike could occur in October.

"A continued weakening of the yen will push up core inflation, thus potentially becoming a key trigger for policy action," she stated