Japan: Upper House Victory Paves The Way For Political Stability‏

The LDP-led coalition government as expected won a landslide victory in connection with the Upper House election and now has a clear majority in both Houses. The landslide victory largely reflects the government's success in kick-starting the economy through aggressive easing as bread and butter issues have been the main focus for voters. The Japanese electorate has been more sceptical about other important parts of the LDP election platform including LDP's plans to restart nuclear power plants and change Japan's pacifist constitution. The government's landslide victory has also been aided by a disunited opposition that has not been able to offer a credible political alternative.

With no major election scheduled until 2016 it appears that Japan is finally showing some political stability. This should give the government room to focus on some of the longer-term challenges Japan faces including stalled economic reforms, the continuing explosive growth in public debt, energy policy after the Fukushima nuclear disaster and its future defence and security policy in the shadow of a rising China.

In our view the economic policy will now shift its focus to structural economic reforms and improving public finances. This autumn the government is expected to give more details about its longer-term growth strategy and next year the consumption tax will be raised and fiscal policy will be tightened substantially. Hence, we expect the current strong recovery in Japan to lose considerable steam next year and monetary policy will need to stay extremely accommodative in 2014, when most other major central banks are expected to gradually exit their QE-programmes. This remains the anchor for our forecast of a weaker yen next year.

The main risk is that Prime Minister Abe after the Upper House election follows his deep nationalistic instincts and loses interest in his economic agenda and instead starts to focus on divisive political issues like major changes in the constitution and revisionism of Japan's history. This has the potential to fuel current tensions with China and South Korea further. Hence, while the victory might open up for domestic political stability, it could also fuel geopolitical tensions in East Asia.

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