Takashi Wanasae's fiscal policy has become a "dragging force" on the Japanese yen. The Bank of Japan may be forced to raise interest rates in April.

A former member of the Bank of Japan's policy-setting committee said that due to growing concerns in the market about Prime Minister Sanae Takamichi's "dangerous" fiscal policy stance, the yen has continued to weaken, and the Bank of Japan may raise the benchmark interest rate as early as April. Makoto Sakurai, a former member of the Bank of Japan's policy-setting committee, said in an interview: "The Bank of Japan must raise interest rates at least once before June or July. But this action could also be brought forward to April." At the time these remarks were made, the yen fell further due to local media reports that Sanae Takamichi plans to hold early elections next month. On Tuesday morning, the yen against the dollar touched 158.50 in Tokyo markets, hitting its lowest level in a year and approaching the level when the Ministry of Finance intervened in the foreign exchange market in 2024. Sakurai's views indicate that he believes the Bank of Japan will not take action to support the yen in the next two meetings, which means that if the yen continues to weaken, the responsibility to support the exchange rate during this period will fall on the Finance Ministry. While the Bank of Japan raised borrowing costs to 0.75% last month ( the highest level in thirty years), it only acted as a "brake" to prevent the yen from falling further and did not push the exchange rate higher as in normal rate hikes. The recent depreciation of the yen seems to reflect market participants' view that if Sanae Takamichi wins in the early elections, it will enhance confidence in her more expansionary fiscal spending plans. Sakurai said, "After unnecessary large economic stimulus packages and budget plans for the next fiscal year, the market does not truly trust Sanae Takamichi." "The question is simple: since inflation has stabilized, why expand fiscal spending on such a large scale?" It is widely expected that the committee led by Governor Kazuo Ueta will raise rates at a pace of about once every six months. Therefore, a rate hike in April would be earlier than the market consensus. According to overnight swap trading data on Tuesday morning, traders believe there is about a 40% probability of a rate hike in April. Sakurai said that potential concerns in the market about Sanae Takamichi's fiscal stance will keep the yen weak or even weaken further, which will affect the Bank's interest rate decisions, as a weaker yen will exacerbate inflation pressure through higher import costs. Key inflation indicators to be released next week are expected to show that average price increases over the four calendar years until 2025 are above the Bank of Japan's 2% target, the longest such period since 1992. With the long-term increase in living costs, the committee led by Ueta has signaled close attention to the impact of the yen's weakening on prices. Currently, the yen exchange rate continues to hover around levels that triggered four interventions by the Japanese authorities in 2024. With Sanae Takamichi's support for government spending to stimulate growth and criticism of the Bank of Japan's rate hikes, the yen resumed its declining trend in early October last year. Since taking office in October last year, Sanae Takamichi has announced the largest supplemental budget since the COVID-19 pandemic, as well as the largest initial annual budget in history. Prime Minister Sanae Takamichi has repeatedly stated that she intends to implement an active but responsible fiscal policy. Supporters of Sanae Takamichi argue that with inflation raising tax revenue to record levels and expanding the nominal economic size, thereby reducing the proportion of Japan's debt to GDP, Japan's fiscal situation has improved. Sakurai said, "Inflation has increased tax revenues indeed, but Sanae Takamichi decided on expenditures without finding a source of funds first." "This is a very loose and dangerous approach." Traders also seem unconvinced, as the ultra-long bond yields, which are the most sensitive to the government's long-term fiscal stance, have shown a rapid rise. The 30-year JGB yield touched 3.52% on Tuesday morning, setting a new record high, compared to around 3% at the end of October. "Sanae Takamichi's fiscal measures are causing the yen to weaken," Sakurai said. "It will be difficult to rebuild market trust."