Summary
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• Japanese snap election scheduled for Saturday, October 27, marking a critical juncture in the nation's political landscape
• Governing Liberal Democratic Party (LDP) seeks to maintain power, but faces increasing uncertainty amidst recent polls and public sentiment
• Bank of Japan's monetary policy outlook may face complications if the LDP fails to secure a clear majority, potentially impacting future interest rate decisions
• Japanese yen could experience downward pressure if the newly elected government prioritizes expansionary fiscal policies over monetary tightening
• Election outcome holds significant implications for Japan's economic trajectory and global financial markets

Japan's Election on October 27

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Japan will hold a general election on October 27, just before the US presidential election and the November 7 Fed meeting. This election is crucial for Japan and the Bank of Japan, which recently raised interest rates for the first time in nearly two decades and may continue to tighten monetary policy.

Reason for Snap Election

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Former Prime Minister Fumio Kishida resigned in August plagued by scandal, quickly replaced by Shigeru Ishiba. Ishiba won the Liberal Democratic Party (LDP) leadership contest and called for a snap election on October 27, a year earlier than scheduled, despite the LDP's strong majority in the lower house.

New Prime Minister's Background

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Ishiba became LDP leader after several attempts, narrowly losing to former PM Abe in 2012. He focuses on defence and foreign affairs, advocating for an Asian NATO and stronger military to counter China.
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Ishiba favours stimulus over fiscal consolidation, despite Japan's high debt-to-GDP ratio. He's announced rural support packages and discussed changingJapan's flat tax structure. While he seems more reform-minded than his predecessor, his policies will depend on election results and economic conditions.

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Ishiba's Stance on the Bank of Japan

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Initially, Ishiba's victory in the LDP leadership race sparked market optimism, with the yen strengthening and stocks declining due to his perceived hawkish stance compared to his LDP rival, Sanae Takaichi. However, Ishiba and the new economic minister have since moderated their position during the pre-election period.

Recent statements such as "additional rate hikes are not currently appropriate" and "caution is needed when raising rates as exiting deflation takes time" indicate a shift in the new LDP leadership's approach. While the BoJ's autonomy remains intact, historical evidence suggests that Japan's economic progress relies on coordinated fiscal and monetary policies.

Market expectations currently indicate a 70% likelihood of a10-basis point rate increase on December 19. This decision hinges on theOctober 27 election results and external factors including the U.S.presidential election, Federal Reserve decisions, and Middle East developments.One potential bright spot for BoJ hawks is the report that Rengo, Japan's largest labour union, aims for a wage increase exceeding 5% in next year's spring negotiations.

Recent Polls Indicate Uncertainty in LDP's Majority

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Initial polls following the snap election announcement suggested the LDP would comfortably secure the 233 seats required for a majority, potentially forming a government with their coalition partner, the Komeito party. However, recent surveys have introduced uncertainty, indicating a possibility that the LDP may underperform on October 27, potentially falling short of an outright majority.

Key Election Scenarios

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1. LDP Secures Comfortable Victory and Forms Government with Komeito – 60% Probability
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Despite a significant portion of undecided voters and ongoing LDP controversies, the fragmented opposition suggests that the Japanese electorate may likely grant the LDP another term.

A decisive victory would enable Ishiba to implement his proposed fiscal expansion strategy, potentially at the expense of monetary policy tightening. While the Bank of Japan may remain open to further rate increases, the lack of policy coordination could impact current economic dynamics. This scenario may lead to yen depreciation, with the USD/JPY potentially surpassing the 152 threshold.

2. LDP and Allies Achieve Narrow Majority – 30% Probability
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Recent polls suggest increasing likelihood for this outcome.In this scenario, newly appointed Prime Minister Ishiba may need to pursue greater coordination with the Bank of Japan. Having finally secured the premiership, Ishiba will likely prioritise maintaining his position.

Ishiba is expected to proceed with his fiscal expansion plans, albeit with funding sources that may raise concerns, as tax increases could negatively impact consumption. Nevertheless, the possibility of aDecember Bank of Japan rate hike remains, potentially leading to a partial reversal of the yen's recent underperformance.

3. No Majority Achieved, Coalition Negotiations or New Election – 10%Probability
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This scenario presents significant challenges for the Bank of Japan, as political uncertainty may necessitate a postponement of rate decisions pending resolution. Negotiations for a broader coalition would likely ensue, potentially resulting in an agreement, given the rarity of minority governments in Japan.

Under these circumstances, the yen may face continued pressure, with the USD/JPY potentially extending its upward trajectory. This trend could accelerate if upcoming U.S. economic data remains robust.

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