The Bank of Japan faces increased pressure to raise interest rates this month! The yen depreciates sharply, and Governor Kazuo Ueda's vision of "slow rate hikes" is put to the test

According to Zhitong Finance APP, Japanese Prime Minister candidate Sanae Takaichi has won the Liberal Democratic Party (LDP) presidential election, which may prompt the Bank of Japan to raise interest rates this month. Since Takaichi advocates for a loose monetary policy, the yen has depreciated following her election as LDP president. On Thursday, the yen fell to 153.22 yen per dollar, marking a new low in nearly eight months.

The weakening yen will increase import costs, thereby exacerbating inflationary pressures. This outcome will heighten the risk of rising prices faced by the Bank of Japan, and may also complicate Takaichi's plans aimed at alleviating the impact of the cost of living crisis.

The softening yen will become one of the first tests for Takaichi if she is expected to assume the role of Prime Minister, along with her ability to form a stable coalition government. Although she is known for supporting monetary easing policies, this stance may exacerbate inflation and provoke voter dissatisfaction. If the yen continues to fall below the 160 mark, and the Bank of Japan maintains interest rates, the Japanese Ministry of Finance may have to intervene in the market to halt this trend.

Daisuke Karakama, Chief Market Economist at Mizuho Bank, stated: "In the case of Takaichi's election, the possibility of an interest rate hike in October will increase due to the depreciation of the yen. The public's dissatisfaction with inflation caused by the yen's depreciation is extremely strong."

Following Takaichi's victory in the ruling Liberal Democratic Party leadership election held on Saturday, market expectations for an interest rate hike have significantly decreased, and the yen began to depreciate rapidly. Traders believe that when the Bank of Japan announces its next policy decision on October 30, the likelihood of an interest rate hike is about 25%, down from 68% last week.

Since Takaichi's victory, the yen has fallen more than 3.5% against the dollar, the largest decline among all major currencies during this period. Etsuro Honda, one of Takaichi's economic advisors, stated earlier this week that October may not be the right time for the Bank of Japan to take action, but he also pointed out that if the yen falls below 150, it would be somewhat excessive, as this would push up inflation.

Economist Taro Kimura noted: "If the Bank of Japan delays raising interest rates, the market may begin to question its independence. There remains a possibility that the Bank of Japan will continue to maintain a tightening policy in the delicate balance between political and central bank functions."

Analysts pointed out that if Japanese leaders seem to delay interest rate hikes and cause the yen to depreciate, it would not be good news for the United States. Former President Trump has stated that Japan is trying to gain an advantage through a low exchange rate. U.S. Treasury Secretary Mnuchin remarked in August that the Bank of Japan has been slow to act in response to inflation, a rare comment since he took office Eiichiro Miura, Senior Investment Manager at Nissay Asset Management, stated: "The market is testing the positions of Liberal Democratic Party President Sanae Takaichi, the Ministry of Finance, and the Bank of Japan. Before reaching 160, Takaichi is likely to be persuaded by the Bank of Japan. Additionally, there may also be interest rate pressure from the United States."

The Liberal Democratic Party, to which Takaichi belongs, lost control of both houses of parliament in the recent national elections, with public dissatisfaction over the cost of living seen as one of the main reasons. Japan's key inflation indicators have remained at or above the Bank of Japan's target level of 2% for three consecutive years, leading to a continuous decline in real wages.

Since 2022, Japan has invested approximately 24.5 trillion yen (about 160 billion USD) to support the yen's exchange rate through interventions in the foreign exchange market. Japanese Finance Minister Shunichi Suzuki stated on Tuesday that authorities are not currently prepared to take intervention measures again. His statement that "the Ministry of Finance is closely monitoring any excessive movements" is not sufficient to be considered a clear warning of imminent action