Election throws Japan into turbulent waters

October surprise. An election meant to deliver greater certainty has yielded anything but. The Liberal Democratic Party lost its parliamentary majority in the snap election held on Sunday, called by Shigeru Ishiba soon after becoming prime minister last month, who hoped to minimise gains by the opposition and lock in a firm mandate for his scandal-ridden coalition. Now the opposition Constitutional Democratic Party of Japan (CDPJ) has gained 50 seats, largely at the LDP’s expense, leaving all parties short of the necessary 233-seat majority.

The outcome will have every faction in the Lower House scrambling to recalibrate — and markets along with them. The CDPJ, which wants to change the Bank of Japan's inflation target from 2% to “above 0%”, has vowed to try and cobble together a coalition to oust the incumbents.

The LDP and its smaller ally, the Komeito Party, will attempt to find new backers, but the largest potential kingmakers have so far ruled out a post-election alliance. Japan’s constitution mandates a special session within 30 days of the election to choose a prime minister, and without a clear path to full control, the LDP may opt to try and govern as a minority.

On that front, Ishiba had already promised in the run-up to the election to deliver a bigger supplementary budget before the end of this year. His party will only face more pressure to deliver fiscal and monetary easing now that it’s on the ropes. That could provide breathing room in the short-term for listed companies under pressure from the push towards higher rates, and may help explain why the Topix rose more than 1% in early trading on Monday. But it bodes ill for the government’s capacity to continue the reforms that had put Japan on a path out of stagnation for the first time in decades.

Then there is the question of whether the LDP itself can stay on target. Ishiba will face serious pressure to resign following the electoral rout, throwing the spotlight on his many rivals for party leadership. Chief among these is Sanae Takaichi, a member of the party’s right wing who narrowly lost to Ishiba and argued late last month that it “would be stupid to raise interest rates now”. Should she take control, it could make unlikely bedfellows of the Lower House’s two biggest parties, at least when it comes to interest rate policy. That would be good for Japanese equities, but bad for Japan.

Context News

The Liberal Democratic Party’s coalition lost its parliamentary majority in the snap election on Oct. 27 called by Prime Minister Shigeru Ishiba, dropping from a combined 279 seats to just 215, per Reuters. The Constitutional Democratic Party of Japan won the most new seats, rising from 98 to 148 seats but still far short of the necessary 233-seat majority. The parties have 30 days to assemble a majority coalition or the LDP and longtime ally Komeito may attempt to govern as a minority.