Bank of Japan May Face Pressure to Ease Policy After DPJ's Election Defeat

Pressure on the Bank of Japan to fight deflation is likely to increase following the coalition government’s defeat in mid-term elections, economists said.

Prime Minister Naoto Kan lost control of parliament’s upper house in yesterday’s contest, meaning he will have to rely on smaller parties to pass laws smoothly. While that may undermine his ability to cut the world’s largest public debt, his adversaries at least agree on the need for a swift end to the price declines that are undermining the economic recovery.

“The common understanding among parties during the election was deflation shouldn’t be left unsolved,” said Hideo Kumano, a former central bank official and now chief economist at Dai-Ichi Life Research Institute in Tokyo. “Pressure on the BOJ will probably build.”

Governor Masaaki Shirakawa and his colleagues are unlikely to take action at a policy meeting this week, though the prospect of slower economic growth and political coercion could force them to ease monetary conditions in coming months, such as by increasing bond purchases, said economist Susumu Kato.

“The government may put more focus on escaping deflation as its basic economic policy, at a time when economic growth is set to slow,” said Kato, chief economist for Japan in Tokyo at Credit Agricole CIB and CLSA. “The Your Party, especially, may strongly call for further monetary easing.”

Pursue Alliances

Kan’s ruling Democratic Party of Japan won 44 seats, compared with 51 for the opposition Liberal Democratic Party, according to results compiled by public broadcaster NHK. Your Party, a group founded by former LDP cabinet minister Yoshimi Watanabe that has advocated monetary easing, won 10. Half of the 242 seats in the less powerful of Japan’s two houses of parliament were up for grabs.

The prime minister, who took office last month, said he wouldn’t step down after failing to meet his goal of winning at least 54 seats, adding that he will pursue “policy-based” alliances with other parties. Kan blamed his “insufficient” explanation to the public of the need for a sales tax increase as a reason for the defeat.

Your Party leader Watanabe said that while he isn’t interested in joining Kan’s coalition, he will work with the government “if we have common agendas” on specific issues. In its campaign platform, the party, formed last year, said it wants to set an inflation target and seek further monetary easing to boost growth and tackle deflation.

Dai-Ichi’s Kumano and Takahide Kiuchi at Nomura Securities Co. said financial-market volatility could be the trigger for additional government pressure on the central bank.

Rising Yen

The yen has surged 4.7 percent against the dollar and 13 percent versus the euro in the past three months, threatening to erode earnings among the exporters who have led Japan’s recovery. Japan’s Nikkei 225 Stock Average slid 15 percent in the same period.

“The focus after the election will be on how the government tries to overcome deflation and maintain stability in financial markets and the economy,” Tokyo-based Kiuchi said. “Given the nation’s severe fiscal condition, there’s little room for the government to spend more, and so it will likely demand additional measures from the central bank.”

The Nikkei rose 0.1 percent to 9,592.11 at the 11 a.m. lunch break in Tokyo. The yen weakened 0.5 percent versus the dollar and 0.2 percent against the euro. The yield on Japan’s 10-year bond fell half a basis point to 1.145 percent.

“Should the yen or bond yields surge, dependence on monetary policy as a safety net will likely increase more and more,” Kumano said.

‘Very Accommodative’

Shirakawa said in a speech last week that he would continue to pursue a “very accommodative” policy to combat price declines.

The central bank cut the benchmark interest rate to 0.1 percent in December 2008. Following political pressure to tackle falling prices, last December it unveiled a 10 trillion yen loan program for banks and doubled the facility in March. In June, the bank released details of a separate 3 trillion yen plan to encourage lending to companies.

Former Bank of Japan official Hiromichi Shirakawa, who is unrelated to the governor, said that the election loss means Kan’s pursuit of a sales tax increase “will fade out and monetary reflation may strengthen instead.”

“The BOJ is the one who is the most wary of the DPJ’s debacle,” said Shirakawa, who is now chief Japan economist at Credit Suisse Group AG in Tokyo.

To contact the reporter on this story: Keiko Ujikane in Tokyo at kujikane@bloomberg.net

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