By Elaine Lies and Shinichi Saoshiro
TOKYO, Aug 25 (Reuters) - Japan looks headed for a historic change in government at an election to be held on Aug. 30 that is expected to end more than half a century of rule by the conservative Liberal Democratic Party (LDP).
Opinion polls show the main opposition Democratic Party of Japan ahead of the LDP. A solid win for the Democrats would raise the chance of clearing a policy deadlock in parliament, where the opposition controls the upper house and can delay legislation.
Following are expected reactions in stocks, bonds and the currency market to possible outcomes to the vote.
CLEAR WIN FOR OPPOSITION DEMOCRATS
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Financial markets are broadly expecting a victory for the Democrats after months of polls showing them ahead.
STOCKS: Have mostly factored in a Democrat victory but a confirmation would be seen as positive in the short term as it would clear policy deadlock between the upper and lower house and open the way to swift policy enactment. Longer term, the market will want to see policies that support the economy. The Nikkei share average hit a 10-month high this month and has jumped by half from a 26-year closing low in March. Stocks may rise initially though sectors such as healthcare and child-related shares may see some profit-taking after gaining in anticipation of a Democrat win.
BONDS: Have had time to get used to the idea of a Democrat government so immediate reaction should be limited unless stocks rise strongly, in which case yields are seen rising. Yields are likely to edge up later on expectation of more government debt issuance to cover a tax shortfall and support spending plans and some see the benchmark 10-year government bond yield, now at 1.32 percent, as high as 1.80 percent by the end of the year. But others say a poor economic outlook and deflation prospects could cap the rise to 1.45 percent or even take yield as low as 1.1 percent by year end.
YEN: Little reaction is expected near-term, unless it gains on the back of a rise in bond yields. Longer term, the FX market doubts Democrats' FX policy will change much from the LDP but speculation the Bank of Japan could normalise monetary policy more quickly under the Democrats might support the yen which has eased to 7 percent to 94 per dollar after hitting a 13-year high of 87.10 per dollar in January.
DEMOCRATS FALL SHORT OF MAJORITY, NEED COALITION
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This would still be a Democrat win, as it has established relationships with which to form a coalition, but it is seen as a weaker government than an outright win for the party.
STOCKS: Not as immediately positive as a solid win and could be slightly negative if a new coalition looks weak.
BONDS: Short-term, this might see some bond buying because of the uncertainty and any potentially negative impact on stocks. Longer term, though, it is not seen as leading to strong government and concerns about decision-making and fiscal management might send yields higher.
YEN: Again, likely to follow bond yields but also driven by what is happening in global economy.
NO CLEAR WINNER, BIG PARTIES HORSE-TRADE WITH SMALLER ONES
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For many in the markets, this unexpected result would be the worst outcome as it would mean policy confusion and weak government.
STOCKS: Immediate uncertainty would be negative. Medium term, market reaction would depend on who forms a government but in either case the risk is that policy-making would be hindered.
BONDS: Possibly initially short-term positive for bonds but longer term concerns that policy-making would be hindered and smaller coalition parties would demand concessions.
YEN: Some say this could lead to yen selling, as the FX market is still driven by risk aversion as well as a search for yield.
RULING BLOC STAYS IN POWER
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This would be the biggest surprise for the markets. Some say the impact on markets, after the initial surprise, would not be that great as not much would be expected to change but others note that a policy deadlock would worsen because ruling bloc would almost certainly lose its ability to override opposition control of parliament's upper house.
STOCKS: First reaction likely to be negative as it would mean continued division between upper and lower house. But sectors that have benefited under LDP such as construction, which have fallen ahead of vote, might get a lift.
BONDS: Initially yields could fall as stocks fall, as the Liberal Democrats are seen as less fiscally expansionary than the Democrats. But medium/longer term, yields likely to rise as market expects whoever gets in will have to issue more bonds to fund a supplementary budget to cover likely tax shortfall and extra stimulus spending.
YEN: Could weaken as yields fall, with concern over continued policy deadlock. (Additional reporting by Masayuki Kitano, Aiko Hayashi, Kaori Kaneko and Charlotte Cooper; Editing by Kazunori Takada)