Japan: Post-Abe policy outlook

We examine the implications for Japan’s fiscal/monetary policy and the yen after Abe’s assassination.
Group Research, Ma Tieying12 Jul 2022
  • PM Kishida is likely to inherit Abe’s legacy, endorsed by the upper house election results
  • A small difference in Kishida’s economic policies is the emphasis on inclusive growth
  • His government is likely to unveil more measures to cushion the impact of inflation after election
  • The Bank of Japan is expected to maintain the ultra-loose monetary policy in the near term
  • Monetary policy uncertainty may increase along with Governor Kuroda’s term ends in 2023
Photo credit: AFP Photo

Abe’s assassination and upper house election

Former Prime Minister Shinzo Abe passed away on July 8th after being shot during a campaign event in Nara. Abe was the longest-serving prime minister in Japan’s history (2012-2020). He successfully pushed through a series of economic policies dubbed Abenomics. These include implementing bold monetary easing to address deflation, raising the consumption tax to reduce the fiscal deficit, joining the CPTPP to promote free trade, and boosting female labor participation to ease the pressure of population aging, among others. He remained active after stepping down as the prime minister in 2020.

The incumbent Prime Minister Fumio Kishida is likely to inherit Abe’s legacy. He comes from the ruling Liberal Democratic Party (LDP), albeit a different faction. During the election held after Abe’s assassination on July 10th, the LDP coalition secured 76 seats and strengthened its majority in the Upper House. This increases the likelihood for Kishida to stay as the prime minister in the next three years – he is required to call the nationwide lower house election before October 2025.

Implications for fiscal policy

Like Abe, Kishida also advocates a flexible fiscal policy. He has pushed for a sizable fiscal stimulus to revive the Japanese economy after taking office in October 2021. For instance, his government unveiled a JPY 36tn supplementary budget in November 2021 (6% of GDP), to cushion the impact of the Covid pandemic.

A small difference between Kishida and Abe’s policies is that the former emphasizes inclusive growth. Kishida has proposed the so-called “New Capitalism” to address the income disparity caused by the Covid pandemic. In response to the recent surge in energy prices, his government approved a JPY 2.7tn supplementary budget in May, to finance the measures such as subsidies on oil wholesalers and cash handouts to low-income families.

His government is likely to expand these measures after the election, e.g., extending the fuel subsidy program, providing subsidies to curb food prices, and introducing more incentives to encourage companies to raise wages.

Implications for monetary policy

There is no indication that the Bank of Japan (BOJ) will change its ultra-loose monetary policy in the near term. The incumbent BOJ Governor Haruhiko Kuroda, who Abe appointed in 2013, is a strong supporter of Abenomics. He introduced Quantitative and Qualitative easing in April 2013, Negative Interest Rate Policy in January 2016, and Yield Curve Control (YCC) in September 2016.

Recently, Kuroda sent a strong signal that the BOJ will not abandon YCC in the near term because the economy remains weak, wage growth is insufficient, and the energy-driven inflation is not a lasting phenomenon. In response to the foreign selling pressure in the JGB market, the BOJ announced daily fixed rate operations at the April meeting. It increased the quantity of bond purchases, owning about 50% of the outstanding JGBs as of end-June.

In the longer term, there is some uncertainty about BOJ’s policy direction after Kuroda’s term ends in April 2023. It is currently unclear whom Kishida may appoint as the next BOJ governor and whether the next governor will be more moderate than Kuroda on monetary policy easing. Kishida’s latest stance on monetary issues is not very clear. On the one hand, his government stepped up verbal interventions in the FX market, warning of the yen’s rapid decline. On the other hand, Kishida also backed the BOJ’s loose monetary policy, saying that monetary policy and exchange rates should be dealt with separately.

Implications for the yen

The yen’s movement in 1H 2022 was largely driven by the monetary policy divergence between Japan and the US. USD/JPY has exhibited a tight correlation with the nominal interest rate differentials, i.e., 10Y UST-10Y JGB yield, since March. Expectations for the BOJ to maintain its ultra-loose monetary policy will likely be reinforced in the near term, thanks to the favorable upper house election results.

Beyond the short term, whether the yen’s momentum driven by interest rate differentials will be sustained is a question. The FX hedging costs for Japanese investors have increased sharply due to rising yen volatility. This has reduced the attraction of UST yields to Japanese investors, resulting in Japan’s net selling of foreign bonds (JPY3.8tn in June) and repatriation of overseas funds. In the longer term, the risk of a yen reversal may also increase due to speculations about BOJ policy normalisation under a new governor after 2023.

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Ma Tieying 馬鐵英, CFA

Senior Economist - Japan, South Korea, & Taiwan 經濟學家 - 日本, 南韓及台灣

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