MNI INSIGHT: BOJ Believes Japan Election, Fed To Keep Yen Weak

--Weak Yen Gives BOJ Breathing Room To Pursue 2% Inflation Goal

By Hiroshi Inoue

     TOKYO (MNI) - Prime Minister Shinzo Abe's decision to call a snap election

for next month and the U.S. Federal Reserve's continued policy tightening should

keep the yen relatively weak, buying the Bank of Japan some more time to guide

inflation a little closer to its 2% target, BOJ officials believe.

     However, the officials are not completely ruling out the risks that Abe's

ruling coalition could lose its majority, that the Fed will slow the pace of its

policy tightening due to continued weak inflation or that renewed investor risk

aversion will emerge due to geopolitical risks, all of which would put upward

pressure on the yen.

     Government and BOJ policymakers are comfortable with the dollar-yen

exchange rate ranging between Y105 and Y120. A rapid move either way beyond that

range would cause concern of a negative impact on Japan's modest economic

recovery. A stronger yen, in particular, would be troublesome, as it would cut

exporter profits and business sentiment, hurting the stock markets. It would

also lower import costs, making it harder for the BOJ to reach its 2% inflation

goal.

     While Japanese stock markets have been buoyant and the yen has depreciated

in recent trade, a resumption of investor risk aversion, which would prompt

safe-haven yen buying, could be triggered by heightened tensions between North

Korea and the U.S. over Pyongyang's nuclear arms threat.

     The coalition between Abe's Liberal Democratic Party and its small partner

Komeito are expected to lose some of their combined 322 seats in the Lower House

but are now seen likely to secure a simple majority of 233 seats. The lower

chamber's 475 seats will be reduced to 465 as part of parliamentary reform for

the next election.

     The BOJ is cautious, but hopeful, on the overall outlook.

     "The election results are highly uncertain and it is impossible to predict

the outlook for geopolitical risks," said a person familiar with BOJ thinking.

     "But looking ahead, as long as Prime Minister Abe stays in power, the trend

of the weak yen and the prospect for the government appointing a BOJ governor

who supports the easy policy stance should remain intact."

     The person added that a rapid yen rise on renewed investor risk aversion

would be a "very troublesome factor" for Japan's economy.

     Abe returned to power in late 2012, promising to correct the excessive

appreciation of the yen and "regain Japan" by overcoming deflation and being

more assertive in diplomacy.

     The five-year term of BOJ Governor Haruhiko Kuroda ends on April 8 next

year. The Prime Minister's Office is expected to short-list his successor toward

the end of the year for parliamentary approval early next year.

     Abe announced Monday that he will dissolve the Lower House on Thursday to

call an early election to seek voter approval of a "drastic shift" in government

policy toward using the planned sales tax hike to fund new program spending

totaling Y2 trillion.

     Abe has defended his reflationary policy mix of aggressive monetary easing,

increased fiscal spending and structural reforms, saying more jobs have been

created since he returned to power in late 2012, although inflation remains far

from the 2% he had promised to achieve.

     Last week Fed policymakers decided to gradually shrink the central bank's

balance sheet starting in late October and left a December rate hike on the

table. Tighter U.S. monetary policy would increase the interest rate

differential between the U.S. and Japan, which would support demand for the

dollar.

     The yen weakened to around Y112.50 Thursday, a two-month low. The Nikkei

225 stock index closed at 20,397.58 Monday, up 101.13 points, or 0.50%, from

Friday's close, the highest level in two years.

     Another person familiar with BOJ thinking warned of the risk that Abe's

decision to push back his initial target for achieving a primary budget surplus

in fiscal 2020 by using the 2019 sales tax hike to fund his new spending

programs could cause a downgrading of Japan's sovereign debt ratings.

     However, the person said the impact of any downgrade on the Japanese

government bond market would be temporary, as the JGB market has exhibited only

knee-jerk reactions to ratings news in the past. Moody's Investors Service last

downgraded the credit ratings of Japan's debt to A1 from Aa3 in December 2014.

     It is uncertain if the Party of Hope, the new reform-minded conservative

party launched this week by Yuriko Koike, a popular Tokyo governor, will become

a threat to the current ruling coalition.

     There is little difference between Abe and Koike in the basic conservative

political stance -- more business-oriented in shoring up economic growth and

seeking a more assertive role by Japan by rewriting the post-war Pacifist

constitution.

     However, Koike is trying to appear different from Abe by calling for a

complete shutdown of all nuclear power plants in Japan and freezing plans to

raise the sales tax. If voters see a fresh image in Koike's party, it could

emerge as an alternative to Abe's LDP.

--MNI Tokyo Bureau; tel: +81 90-2175-0040; email: hiroshi.inoue@marketnews.com

--MNI Tokyo Bureau; tel: +81 90-4670-5309; email: max.sato@marketnews.com

--MNI BEIJING Bureau; +1 202-371-2121; email: john.carter@mni-news.com

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