Bank of Japan to remain undeterred on rate hikes despite LDP’s shock

Japan’s longtime ruling Liberal Democratic Party may have suffered an election shock, but analysts said that’s unlikely to deter the Bank of Japan from its interest rate hike cycle.

In Sunday’s elections, the LDP lost its majority in Japan’s lower house for the first time since 2009. Besides its junior coalition partner Komeito, the LDP will need to work with other parties to form a government. A minority government could also be on the cards.

The result was a blow to the LDP, David Boling, director of Japan and Asian trade at Eurasia Group, told CNBC’s “Squawk Box Asia.”

“The LDP got bruised. They got a black eye. They got a bloody nose, but they’re still standing, and so is Ishiba, and they are still the biggest party in the lower house,” he said on Monday.

As such, the LDP will still be in the “driving seat” when it comes to putting together a coalition government, which he said is good news.

The political turmoil comes ahead of a Bank of Japan meeting this week. Roughly 86% of economists polled by Reuters expect the central bank to leave its rates unchanged when it announces its decision Thursday.

Izumi Devalier, chief Japan economist at Bank of America, said that the odds that the BOJ will hike this week is “probably close to zero.”

When asked if the election result could derail the BOJ’s hiking cycle, Devalier explained that while political uncertainty and instability could delay rate hikes, she added the BOJ cannot ignore sustained weakness in the yen.

“I don’t think that necessarily means that the BOJ will be on hold for the foreseeable future. Obviously, you’ve got to watch the market developments, but we could still be on track for hikes in January or even December, depending on where the yen goes,” she said.

Citi’s Japan economist, Katsuhiko Aiba, also has similar sentiments, writing in a note that “some believe government instability would make rate hikes difficult for the BOJ, but this is by no means obvious.”

He adds “we continue to see little likelihood of the BOJ being diverted from its rate hike cycle by the government even after the Lower House election. We see a risk, however, if PM Ishiba steps down and Sanae Takaichi were to become the new LDP leader.”

Takaichi recently lost the LDP party election to current Prime Minister Shigeru Ishiba and previously served as minister in charge of economic security. She is in favor of monetary easing and had reportedly warned the BOJ in September against raising rates.

Jesper Koll, expert director at Tokyo-based financial services firm Monex Group, told CNBC that the BOJ will be more independent following the election and carry on with its goal of normalizing its monetary policy.

“Yes, desperate politicians will make bolder calls for BOJ action, but unlike Ishiba, BOJ Governor Ueda knows what he’s doing and has the full support of the people,” he said.

On Monday morning, the benchmark Nikkei 225 rose about 1.73%, leading gains in Asian markets, while the yen weakened to a three month low, trading at 153.49. A weak yen usually boosts Japan’s stocks, which are heavily weighted toward exporters.

BofA’s Devalier said the market movements could be a “knee jerk” reaction and that investors will have to look to the week ahead to see how markets pan out.

In the longer term, Monex Group’s Koll is still bullish on Japan, saying that “unlike the LDP leaders, Japan’s CEOs are getting things done, are focused on creating shareholder value and profitable investments.”

He forecasts that corporate earnings and profits will surprise on the upside over the next 12 to 15 months, growing by 18% to 20% and lifting the Nikkei.

Back in July, Koll had reaffirmed his forecast that the Nikkei will reach 55,000 points by the end of 2025, driven by improving corporate earnings.

Similarly, SMBC’s chief FX strategist Hirofumi Suzuki said the formation of a coalition government is expected to boost stock prices while the yen weakens, as seen in Monday trading.

But further depreciation of the yen could be a catalyst for interest rate hikes, he added, pointing out that the SMBC is monitoring the exchange rate.