(Bloomberg) -- Japan’s ruling coalition is in danger of losing its majority in the lower house of parliament for the first time since 2009, and strategists see the yen and stocks falling on such an outcome.
The ruling Liberal Democratic Party may not garner enough support even in partnership with its long-running ally Komeito at this weekend’s election, according to polls by Asahi and Kyodo News. The LDP may need to form a coalition with smaller parties and this is likely to make it harder for Prime Minister Shigeru Ishiba to push for fiscal consolidation and monetary policy normalization. His future as a leader could also be at stake.
The Oct. 27 polls come after a tumultuous period in which Ishiba’s appointment and rhetoric surrounding the Bank of Japan’s interest-rate hikes whipsawed the yen and sent stocks tumbling. Taken together with the risks stemming from the upcoming US presidential election, the parliamentary vote has the potential to generate another bout of volatility in Japanese assets.
“If the coalition loses a majority and forms a minority government, the Ishiba administration will be severely weakened,” said Shinichi Ichikawa, senior fellow at Pictet Asset Management Japan. “Given there will be an upper house election next year, there is a chance the LDP will hold another presidential election soon if there is rising mood that they won’t be able to win it under Ishiba.”
Support for the LDP has been eroded by a slush fund scandal which began last year. A Kyodo News poll showed 22.6% of respondents backing the LDP in the election, with the lead over the opposition Constitutional Democratic Party narrowing to 8.5% from 14% in a survey taken a week earlier.
For the yen, it’s unclear what will happen after an immediate bout of weakness if the ruling coalition loses its majority. The BOJ operates independently but the government may still seek to exert its influence over the direction of monetary policy.
Should Sanae Takaichi, a well-known monetary policy dove, gain influence, the BOJ may face pressure to hold off on further rate increases, and this is likely to compound the yen’s declines. Strategists see a similar outcome if the Democratic Party for the People and the Japan Innovation Party become more prominent. A less likely scenario would be if the Constitutional Democratic Party joins the coalition and pushes for policy normalization, resulting in a stronger yen.
“In the event of a change of government, it is unclear which party will take the lead in monetary policy due to the fact that it will be a coalition government,” Mizuho Securities strategists Masafumi Yamamoto and Masayoshi Mihara wrote in a note. “There is a risk of delays in important policy decisions, which could have a negative impact on stock prices, but the direction of the yen exchange rate is unclear.”
The yen slid to 153.19 per dollar on Wednesday, the weakest since July, as the greenback strengthened on receding expectations for aggressive US interest-rate cuts. Japan’s currency dropped the most in over two years in early October after Ishiba said the economy wasn’t ready for more policy tightening, although he later said he was aligned with the BOJ’s views.
Not everyone thinks this weekend’s election will be negative for Japan’s markets.
Despite predicted losses for the LDP, a change in administration remains unlikely, meaning any negative impact on stocks will probably be mild and short-lived, said Neil Newman, head of strategy at Astris Advisory Japan.
Many investors will be more focused on the outcome of next week’s monetary policy meeting, Newman added. “The BOJ’s policy of raising rates is basically already set in stone, although the speed at which they execute it might depend on the state of the government post-election,” he said.
But, JPMorgan Chase & Co. notes that Japan’s stock market is factoring in a scenario where the ruling coalition will lose its majority, strategists including Rie Nishihara wrote in a note. History suggests that share prices will fall or at best remain unchanged unless the LDP wins 60% of seats on its own, they added.
More specifically, defense stocks are likely to take a hit as they had gained on expectations that Ishiba — a former defense minister — will increase spending on security, said Chiyo Takatori, an analyst at Daiwa Securities. Shares of machinery manufacturers Mitsubishi Heavy Industries Ltd. and IHI Corp. have fallen in recent days following an earlier rally.
On the other hand, consumer names such as department stores, restaurant operators and leisure-related stocks will probably benefit, according to Takatori. “Political parties will likely push for policies that are appealing to voters such as minimum wage hikes and measures on inflation ahead of the upper house election,” she said. “That could be positive for consumption.”
--With assistance from Alice French.
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