The Japanese government is preparing a new long-term economic policy document, which shows a notable shift in its phrasing regarding monetary policy direction. According to a draft seen by Reuters, the government plans to emphasize stimulating private demand by maintaining low financing costs, revealing a potential divergence from the Bank of Japan's gradual policy tightening path.
The draft states that, as the government advances its economic and fiscal policies to achieve stable growth, "an appropriate monetary policy to support private demand through stable price increases is extremely important."
The document also cites legal provisions on policy coordination, requiring the Bank of Japan to align its decisions with the government and to "work closely with the government to achieve its 2% inflation target in a sustainable and stable manner," while monitoring a "virtuous cycle" of wage and price increases.
Compared to the traditionally vague language on monetary policy in similar documents from previous governments, this draft, spearheaded by Prime Minister Hayashi, adopts more direct wording. It not only explicitly supports private demand but also stresses the need for the central bank to coordinate with government policy. This change is seen as a signal of the government's cautious or even resistant stance towards further interest rate hikes.
The draft further proposes that the government will take "flexible and sufficient" measures to prevent the economy from falling back into deflation and to promote long-term growth. This approach is consistent with the legacy of "Abenomics." Prime Minister Hayashi is considered a supporter of this policy framework, which previously attempted to pull Japan out of long-term deflation through massive fiscal spending and aggressive monetary easing.
The document also acknowledges that the current economic environment has changed, with inflation hovering near the 2% target, a situation partly driven by energy price shocks stemming from the conflict involving Iran.
Former Bank of Japan policy board member Takahide Kiuchi commented, "While the wording is somewhat indirect, these statements appear to be resisting rate hikes and highlight the government's cautious stance towards the economic downside risks associated with any premature tightening."
Globally, many countries are facing "stagflation" pressures due to rising energy costs from the Iran conflict, characterized by weak growth alongside high inflation. In the United States, high inflation is limiting the new Federal Reserve Chair's room for interest rate cuts and hindering the progress of the loose policy desired by the President.
The domestic market in Japan has already reacted to these policy signals. The draft has somewhat counterbalanced the hawkish stance of Bank of Japan policy board member Naoki Tamura, leading the yield on the 10-year Japanese government bond to fall back to 2.625%. Meanwhile, the yen continues to hover near its lowest level in nearly four decades.
Central Bank Independence and Policy Tensions Rise
This blueprint is expected to be finalized in July, marking the first long-term economic plan formulated since Prime Minister Hayashi took office. She has previously expressed reservations about the Bank of Japan's gradual steps to exit its ultra-loose monetary policy.
Although Japanese law guarantees central bank independence, it also requires the bank to coordinate with the government. This draft reinforces the government's influence over policy direction by citing this very provision.
The Bank of Japan raised its policy rate to 1% this month, a 31-year high, and signaled its intention to continue tightening. One factor driving this shift is that inflation has remained near its target for nearly four years, partly due to rising fuel costs linked to the Iran conflict.
Concurrently, more hawkish voices have emerged within the central bank. Policy board member Naoki Tamura stated this Thursday that the bank should consider raising rates "every few months," highlighting concerns over inflation risks.
However, the government's stance is now adding complexity to the central bank's policy-making. The Bank of Japan's next meeting is scheduled for July 30-31, where markets widely expect rates to be held steady, but clues about the future pace of hikes may be provided in its quarterly outlook report.
A summary of opinions from the June meeting showed that a government representative stated the Bank of Japan must take "proactive and appropriate action" if the economic situation worsens, a remark interpreted as dissatisfaction with the tightening path.
Since taking office in October 2025, Prime Minister Hayashi has consistently emphasized boosting the economic recovery through expanded fiscal spending. Against a backdrop of market concerns over Japan's deteriorating fiscal health, this stance had previously pushed government bond yields higher.
Her latest growth strategy proposes investing over 370 trillion yen (approximately $2.3 trillion) by fiscal 2040 in 17 key areas, including artificial intelligence and semiconductors. Such a massive investment plan is easier to implement in a low-interest-rate environment. However, rising inflationary pressures are now compelling the Bank of Japan to increase borrowing costs, creating tension with the government's objectives.
Takahide Kiuchi noted, "The Hayashi government has avoided making explicit comments against rate hikes this year, but the wording of this draft offers a glimpse into its true thinking."
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