Upper House victory paves the way for political stability

Prime Minister Shinzo Abe and his LDP-led coalition government as expected won another landslide victory in connection with Sunday’s Upper House election and now have a clear majority in both the Lower and the Upper House. However, the government did not manage to win a two-third majority in the Upper House, implying that Abe is still dependent on opposition support for pushing through his desired changes in Japan’s pacifist constitution.

The victory largely reflects the government’s success in kick-starting the Japanese economy through aggressive easing as bread and butter issues have been the main focus for voters. The Japanese electorate has been sceptical about other important parts of the LDP election platform including its plans to restart nuclear power plants and changing the country’s pacifist constitution. The government has also been aided by a disunited opposition that has not been able to offer a credible 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. The government will probably allow nuclear reactors to be restarted in H1 14 and hopes the voters’ current fierce resistance against nuclear power will gradually fade.

With growth poised to slow markedly next year we also expect monetary policy to stay very accommodative next year, while most other central banks are expected to gradually exit their QE. This remains the anchor for our expectations of a weaker yen next year.

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