Japan’s post-election puts BOJ in bind as inflation and gridlock loom

In its analysis, Reuters lays bare the growing conundrum facing the Bank of Japan (BOJ) as political fallout from the upper house elections on July 20 threatens to compound already stubborn inflation. 

With Prime Minister Shigeru Ishiba’s ruling coalition suffering a “bruising defeat,” Reuters warns that Japan may be sliding into a policy deadlock just as the BOJ confronts mounting price pressures and a volatile yen.

While inflation has remained above the central bank’s 2 per cent target for over three years, political paralysis now risks stalling decisive monetary action — even as “second-round effects from rising rice costs,” as BOJ board member Junko Koeda put it, begin to ripple across the economy.

Fellow policymaker Hajime Takata stressed that the central bank “must resume rate hikes after a temporary pause,” and the hawkish Naoki Tamura added, “If upward inflation risks heighten, the BOJ may need to act decisively as a guardian of price stability.”

But decisive action may be hard to come by. Ishiba, now leading a minority government in both chambers of parliament, must negotiate with opposition parties pushing for “tax cuts and bigger spending.” As the article points out, that political instability may in turn weaken the yen, further inflating import prices and eroding household purchasing power.

“For the BOJ, the biggest concern is how the election could change the government's focus on economic policy, and how markets could react,” said a source familiar with the central bank’s thinking. The yen — hovering around 147 to the dollar — is now in the spotlight as a potential trigger. Veteran BOJ watcher Mari Iwashita noted that if the currency slips below 150, it could push up underlying inflation, warning that “sustained yen weakness would push up underlying inflation, so could be a key trigger for policy action.”

The tightrope the BOJ now walks. With real interest rates still deeply negative and Japan’s economy already shrinking in Q1, markets had expected a cautious pause. But should the yen fall further, the central bank may be forced into a rate hike — possibly as early as October — even as the government looks to inject fresh fiscal stimulus to placate a restless electorate and shield firms from US tariffs.

As economist Tsuyoshi Ueno put it: “With Ishiba signaling his resolve to stay on as premier, markets are now in a wait-and-see mood. But that doesn't mean the chance of yen declines has disappeared, as the election definitely weakened administration's standings.”

Caught between inflationary heat and political headwinds, the BOJ faces a dilemma that could define Japan’s economic trajectory for the rest of the year.

By Sabina Mammadli