The recent election loss of Japan's ruling Liberal Democratic Party (LDP) has created new uncertainties around the country's fiscal and monetary policies.
Japan may be on the brink of a major shift in economic policy, with the country's future largely hinging on how the incoming government tackles both domestic and international challenges.
Shigeru Ishiba, the Prime Minister of Japan and the President of the LDP, now faces fresh pressure that could push him to increase spending and reconsider his policy of raising interest rates.
After the LDP and its longstanding ally Komeito lost control in the lower house elections this past weekend, questions have emerged over Ishiba's ability to remain in office. Economists suggest the new government may be compelled to adopt a more expansionary fiscal approach to maintain voter support.
Amid growing instability, the LDP may look to build alliances with smaller opposition parties like the Democratic Party for the People (DPFP) and the Japan Innovation Party, though both have ruled out joining a coalition.
During their election campaigns, these parties advocated cutting the consumption tax and reducing electricity costs for low-income households. Ishiba has proposed a supplementary budget exceeding 13 trillion yen (around $85 billion), but public demand might push that figure above 20 trillion yen.
Political uncertainty could further complicate the Bank of Japan’s attempts to unwind decades of monetary stimulus. This year, the BOJ ended its negative interest rate policy and raised short-term rates to 0.25% as Japan approached its 2% inflation target. That being said, the new political landscape could make it more challenging for the BOJ to continue raising rates.
The unstable political landscape may complicate the central bank’s ability to make crucial policy decisions. With political upheaval, the BOJ now faces increased obstacles to raising interest rates by year’s end.
Yuichiro Tamaki, leader of the Democratic Party for the People, has criticized the BOJ for raising rates too soon, while the Japan Innovation Party is advocating for a broader set of central bank objectives, including promoting economic growth and maximizing employment.
The weak yen remains a significant concern, as it drives up the cost of imports and fuels inflation. Should the yen weaken to 160 against the dollar, the BOJ may have to raise rates to prevent further currency devaluation. Aside from that, a possible victory for Donald Trump in the U.S. election on Nov. 5 could speed up this process.
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