BOJ FOCUS-Japan ruling party defeat spells trouble for BOJ

* Policy deadlock likely after upper house election

* Will scupper government economic plans

* Government may turn to BOJ to support the economy

By Leika Kihara

TOKYO, July 12 (BestGrowthStock) – The policy deadlock in Japan
resulting from the ruling party’s drubbing in upper house
elections raises obvious concerns for Prime Minister Naoto Kan.

But the Bank of Japan should be worried too.

The government is likely to turn to the central bank to
ease its already super-loose monetary policy further should the
economic recovery face any risks and so threaten to add to
deflation, which has been at the heart of the economy’s
sluggish performance for years.

A failure to sell a proposal to Japanese voters to double
the country’s sales tax was blamed by Kan for the election
result, so politicians will be reluctant to push fiscal reform
despite the country’s massive debt problems.

On top of that, Kan’s Democratic Party of Japan will now be
reliant on several smaller parties to push policies that may
require compromise, or just lead to gridlock in policy making.

“The Democrats won’t be able to do much in terms of
economic policy, so pressure on the BOJ to do more for the
economy will heighten significantly,” said Koichi Haji, chief
economist at NLI Research Institute.

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BREAKINGVIEWS-Election blessing in disguise [ID:nLDE66B0IZ]

Policy gridlock as ruling party reels [ID:nTOE66A02V]

S&P says political hurdles to fiscal reform [ID:nTOE66B066]

Policies at stake [ID:nTOE66101E]

Japan ruling party’s possible partners [ID:nSGE66B00L]

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The DPJ won 44 seats in the election, far short of Kan’s 54
target. The stinging rebuke deprives the DPJ and its tiny ally
of the dominance needed to push their fiscal and economic
policies smoothly through parliament.

The Democrats may rule the more powerful lower house, but
without an upper house majority as well they face policy
gridlock as a number of small and potential king makers push
their agendas in exchange for their support.

PARTNERS

To be sure, even before the election, markets had
speculated the government might pressure the BOJ to ease policy
once again if the yen keeps climbing to threaten Japan’s all
important exports. [ID:nTOE667043]

But the government will now struggle to push a fiscal
reform agenda and will find it difficult or impossible to
provide any fiscal support for the economy, making pressure on
the central bank more likely.

Following the election, the Democrats have opted to enter
alliances with smaller parties on a policy-by-policy basis,
rather than trying to form a coalition.

Some opposition parties back some of the DPJ’s fiscal
policies, such as raising the sales tax — long seen as a way
to whittle down the country’s public debt, which is double the
size of the $5 trillion economy.

But they are cool to the notion of joining hands with the
Democrats to help pass bills.

On the other hand, there is far less disagreement on the
need for Japan to overcome deflation with easy monetary policy.

“Major opposition parties like the Liberal Democratic Party
and Your Party seem very eager to pursue monetary easing to
beat deflation,” said Hiromichi Shirakawa, chief Japan
economist at Credit Suisse. “I think the BOJ was the one most
alarmed by the Democrat’s big defeat.”

One small party, the Your Party, is touted by analysts as
among the most likely of alliance partners for the Democrats.

They expect it to push a more extreme view on the BOJ’s
role compared with the ruling Democratic Party, another sign of
trouble for the central bank that has argued it has done enough
to pull Japan out of deflation.

Most small parties, including the pro-reform Your Party,
have called on the BOJ to set an inflation target to pull Japan
out of deflation. Such a target would be more binding than the
BOJ’s existing practise whereby it says 1 percent inflation as
ideal for price stability.

INFLATION TARGET

Kan has floated the idea of an inflation target. He has
repeatedly said inflation at or slightly above 1 percent would
be desirable for the economy, although that is a reach for a
country that is seen mired in deflation at least until early
2012.

As finance minister, Kan pressured the BOJ to do more to
beat deflation when the yen shot up to a 14-year high of 84.82
per dollar last November.

With its policy rate already at just 0.1 percent, that led
the BOJ to loosen policy by putting in place a new cheap-loan
programme in December. It expanded the scheme in March.

Your Party wants to push the BOJ further, pledging to
revise the BOJ Law that guarantees central bank independence.

Party head Yoshimi Watanabe told Reuters on Monday he wants
the BOJ Law revised so it is similar to laws governing the U.S.
Federal Reserve by adding the need to seek maximum employment.
[ID:nTOE66B048]

Your Party has won enough seats to submit legislation to
parliament on its own. Analysts doubt the bill will garner
enough support to pass through the Diet, but the proposals are
still a headache for the central bank.

“Your Party’s calls for a bill to pull Japan out of
deflation resonates with views held by some in Kan’s own
party,” said Takeshi Minami, chief economist at Norinchukin
Research Institute.

“It probably won’t go as far as a BOJ Law revision. But the
views could influence government policy. The bank undoubtedly
will come under consistent pressure for further easing.”

Much will depend on how the economy recovers from the
global downturn. It grew at an annualised rate of 5.0 percent
in the first quarter, the second fastest among G7 economies
after Canada.

Many analysts say the BOJ may ease policy again if it sees
any threat to its forecast for the economy to recover
moderately on the back of solid exports to Asia.

So far that has not been the case. But growth may slow
later this year as a firmer yen undermines exports and the
effect of government stimulus measures fades.

BOJ officials are also cautious because of signs of a
potential slowdown in global growth following the euro area
debt crisis and data showing the U.S. recovery is faltering.

The BOJ is independent by law but the government wields
influence over monetary policy because it picks candidates when
vacancies arise on the BOJ board, including that of the
governor, and two government representatives sit in on policy
meetings.
(Additional reporting by Izumi Nakagawa, Kaori Kaneko; Editing
by Neil Fullick)

BOJ FOCUS-Japan ruling party defeat spells trouble for BOJ