BoJ Faces Increasing Risks as QE Drags On

While the Federal Reserve is entering the final phase of its exit strategy, there is no end in sight for the Bank of Japan’s massive monetary easing policy, which has seen nothing but expansion during Governor Haruhiko Kuroda’s term.

But with Japan’s economic sentiment clearly recovered, concerns are now mounting over the policy’s longevity. In addition, the BoJ may face political pressure to curtail its monetary stimulus, and even give up on reappointing Kuroda, if Tokyo Governor Yuriko Koike’s new party wins the general election on Oct. 22, Nikkei reported.

According to the BoJ’s closely watched Tankan quarterly survey released Monday, the key index for large manufacturers’ sentiment stood at 22 in September, its highest since September 2007. A better economic outlook supported by ultra-easy monetary conditions may trigger calls for the stimulus package to be scaled back.

On the economic front, Japan’s economy saw output exceed full capacity by the most in nine years in the April-June quarter, a BoJ estimate showed, a positive sign for the central bank as it seeks to accelerate inflation to its elusive 2% target, according to a Reuters report.

The output gap, which measures the difference between an economy’s actual and potential output, stood at plus 1.22% in April-June, staying in positive territory for the third straight quarter, the BoJ estimate showed on Wednesday.

The positive output gap exceeded 1% for the first time since January-March 2008—months before the collapse of Lehman Brothers triggered a global financial crisis.

The outcome backs up the BoJ’s view that Japan’s economy is gathering enough momentum for inflation to accelerate toward its 2% target, and justifies it from keeping policy steady.

On the political front, Koike’s newly formed Kibo no To, or Party of Hope, is gaining support and could pose a genuine challenge to Prime Minister Shinzo Abe’s Liberal Democratic Party and junior coalition partner Komeito.

The ruling coalition has championed the current accommodating monetary policy, but the BoJ would not enjoy the same level of support from Koike’s party if it wins, and Kuroda could end up headed for the exit door.

But it is important to understand what happens if the bank does start pulling out from its ultra-easy monetary policy.

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