How the Japan election may influence global interest rates

Michael J. Atkin
Portfolio Manager, 10/11/17

  • Japan’s Prime Minister Shinzo Abe has called a snap election to take place October 22.
  • Although Abe is favored to win, the reappointment of Bank of Japan (BoJ) Governor Haruhiko Kuroda may become a larger political issue.
  • New leadership at the BoJ could cause a shift in policy that pushes global rates higher.

The Bank of Japan’s current policy encourages capital exports

Japan’s economy is doing well, and inflation remains short of the goal set by the Bank of Japan when it initiated a negative-interest-rate policy in 2016. So why would the BoJ change course?

The key issue is that BoJ Governor Kuroda’s term ends in April 2018. As long as Kuroda remains at the helm, the BoJ is likely to maintain an inflation target that is extraordinarily difficult to achieve. That means, in turn, that Japanese capital will leave the country in search of higher returns elsewhere. These Japanese capital exports have an influence abroad, helping to keep global interest rates low. Kuroda’s reappointment is crucial to the continuation of the BoJ’s negative-interest-rate policy, but his fate is tied to Prime Minister Abe’s political strength.

A different Bank of Japan regime would affect global rates.

The challengers to Abe

Abe has called a snap parliamentary election this October 22, partly on the expectation that his leadership during the crisis with North Korea might offset a broader recent drop in his popularity. Abe’s Liberal Democrat Party (LDP) has experienced declining popularity since building a two-thirds super majority in parliament, but is facing off in the snap election against a weak opponent in the Democratic Party of Japan (DPJ). In an interesting development, the DPJ has entered into an electoral alliance with a new party, the Party of Hope, which is led by the popular Tokyo governor, Yuriko Koike. This alliance is campaigning on a couple of popular themes, such as canceling the sales tax hike scheduled to go into effect next year, and preventing a resumption of nuclear power that was shuttered after the Fukushima disaster.

The outcome could be like the U.K. snap election

We believe the central scenario for the Japan election is that Abe wins and goes on to reappoint Kuroda, and the current low-rate policy remains in effect for some time. However, there are two risk scenarios, as well. The first is very unlikely: The DPJ/Party of Hope alliance prevails and their leaders replace Kuroda with a new BoJ Governor to clear the way for a policy of higher interest rates. The second risk, still small, is a bit more likely: Abe experiences the fate of United Kingdom Prime Minister Theresa May, who earlier this year called a snap election, hoping to gain parliamentary seats, only to end up weakened. If Abe winds up needing to defend himself against a leadership challenge from within his party, then Kuroda’s reappointment could become a bargaining chip.

An LDP win could sustain Japan’s influence on keeping global rates low

With the LDP expected to prevail on rising approval ratings in recent months, the likelihood has perhaps risen a little that Japan will remain a source of capital exports, and the determination of the BoJ to keep Japanese interest rates low will continue to be an important influence on global rates. A different BoJ regime, installed by a different government, would affect global rates markets significantly.