By Leika Kihara
TOKYO (Reuters) -The new junior party in Japan's ruling coalition is likely to give Prime Minister Sanae Takaichi the green light she needs for a big spending package, but will stop short of supporting a revival of Abenomics-style fiscal and monetary policies.
Takaichi made history this week becoming the country's first female prime minister after she formed a new ruling bloc between her Liberal Democratic Party and the Japan Innovation Party, known as Ishin.
The partnership brings Ishin, which supports tax cuts and wealth distribution but focuses mainly on cutting red tape and wasteful spending, into government for the first time.
Ishin's preference for small government contrasts with opposition parties that call for payouts and tax breaks, and may serve as a counter-weight to Takaichi's bias towards big spending.
"Ishin advocates small and efficient government in contrast to Takaichi, who has championed expansionary fiscal and monetary policy," said Takahide Kiuchi, an economist at Nomura Research Institute. "Cooperation with Ishin could temper Takaichi's policy instincts and lead to a more balanced economic approach."
To be sure, Takaichi is seen deploying a package of spending that exceeds former premier Shigeru Ishiba's 13.9-trillion-yen plan compiled last year, government sources have told Reuters.
The package will include measures agreed upon by the two parties such as gasoline tax cuts, subsidies to curb utility bills and tax breaks for households.
But Ishin has backed down on its earlier calls to temporarily freeze the consumption tax for food, heeding ruling party warnings that it would put too much strain on Japan's long-term finances.
Ishin's co-head Fumitake Fujita said while his party and LDP shared the need to underpin growth with expansionary fiscal policy, Takaichi agreed to push through spending reforms.
"Neither I nor Takaichi is of the view that Japan can resort to reckless spending," Fujita told a television interview on October 16.
ABE'S LEGACY
Takaichi is known as a fan of "Abenomics," a mix of big fiscal spending and bold monetary easing deployed by former premier Shinzo Abe to pull Japan out of prolonged deflation blamed in part on a strong yen that hurt exports.
That has stoked market expectations she may deploy Abenomics 2.0 to revitalise still moribund economic growth.
But with inflation and rising import costs from a weak yen now, the bigger problem for Japan, any spending package will not directly be aimed at stimulating demand, analysts say.
Other restraining forces could come from veteran lawmakers such as former premier and finance minister Taro Aso, who was appointed party vice president and has pushed to keep heavily indebted Japan's fiscal house in order.
Such moderation would be welcomed by some.
"If Ishin can yield influence on Takaichi from the perspective of fiscal discipline, that would be favourable," one ministry official told Reuters on condition of anonymity as he was not authorised to speak publicly.
The biggest difference from the Abenomics of a decade ago could be on the monetary policy front with the Bank of Japan already on course for an increase in still-low interest rates.
Contrary to her past remarks describing the BOJ's rate hike idea as "stupid," Takaichi has said only that she hoped the central bank would pursue moderate inflation backed by wage gains.
Former BOJ Deputy Governor Masazumi Wakatabe, who is known to have the ear of Takaichi, told Reuters that while the BOJ could struggle to raise rates this year, it may proceed with one if prospects of durably meeting its target improve.
Ishin's campaign pledge also calls for normalising the BOJ's "extraordinary" stimulus once the economy is on a solid footing.
Hirofumi Yoshimura, co-leader of Ishin, told Reuters in July that the BOJ should phase out its ultra-loose policy but at a slow, cautious pace.
With rising living costs becoming a political hot potato, both parties are unlikely to push back against a moderate pace of rate hikes, especially if further yen weakening threatens to push up inflation further, analysts say.
"If she puts political pressure on the BOJ, the yen would depreciate further and inflation increase more," said Osamu Takashima, chief FX strategist at Citi in Tokyo.
"She could lose popularity among the Japanese people. This would be a very, very risky game for her."
(Reporting by Leika Kihara; additional reporting by Makiko Yamazaki, Yoshifumi Takemoto and Tamiyuki Kihara; Editing by Sam Holmes)
