Japan elections to give Abenomics fresh momentum

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On 18 November Shinzo Abe, Japan’s prime minister, surprisingly (he’s less than two years into a four-year term and has solid majorities in both houses of parliament)  called a snap election. Abe is seeking a new mandate to push back a scheduled tax increase and endorse his Abenomics (click here to learn more about Abenomics) which he sees as the “only path” toward economic recovery. Financial markets greeted the gambit with caution as they wonder whether the mid-December polls will produce the strengthened mandate that Prime Minister Shinzo Abe appears to be looking for.

Markets had already reacted coolly to local media reports (1) in early November of a possible general election this year. The Japanese yen initially fell against the US dollar (see Figure 1) and the Nikkei 225 share index lost ground (see Figure 2). The 10-year JGB yield fell in a delayed reaction to those reports which were not confirmed until 18/11/14 when PM Abe said he would dissolve the House of Representatives on 21 November and call elections.

Figure 1: Japanese yen vs. US dollar

Figure 2: Nikkei 225 stock index

NO TO TAX HIKE AS FINAL PHASE OF ABENOMICS REQUIRES MORE SUPPORT
Combining the dissolution with the postponement of the next, 2%, consumption tax rate hike from October 2015 to April 2017, it is clear to us that Abe is seeking to boost the flagging support for his pro-growth and pro-inflation Abenomics programme, mainly within own LDP party which together with Komeito, now has a vast 325-seat majority in the 480-seat Diet. Recent scandals and resignations among ministers appear to have weakened Abe’s power within the LDP, but unpopular opposition parties have been unable to capitalise on this.

VICTORY IN THE POLLS – WHAT WOULD IT TAKE?
The question is how many seats Abe needs to declare victory and be able to accelerate Abenomics, especially the ‘third arrow’, or structural reforms, as the government seeks to keep the economy to contract for yet another quarter after shrinkage in the second and third quarter of this year.

Markets have erred so far on the side of caution given Abe’s lack of clarity on what it would take for him to feel confirmed and for his influence within the LDP to get the required boost. Announcing the elections, Abe warned he would step down if the coalition parties lost their overall majority, but rather than this improbable outcome, we believe an LDP loss of more than 10% of its 294 seats, which could threaten its control of key committees, would jeopardise Abe’s position.

RISKS STRETCH BEYOND ABE’S PREMIERSHIP
While a weakened majority could turn Abe into a lame duck, markets see a further risk in the link between the prime minister’s fate and that of governor Kuroda of the Bank of Japan whose extraordinary quantitative easing programme is not only part of Abenomics, but is also supported by the current cabinet.

An outright win for Abe would obviously boost the Japanese equity market, allowing it to focus on improving corporate earnings and a weakening yen as quantitative easing continues. The JGB market should hold stable as the credibility to the government and the central bank are retained (and of course, as the BoJ continues to buy huge amount of JGBs).

Voting is likely to be on 14 December, leaving markets between hope and fear as opinion polls rumble in and speculation on Abe’s chances and those of his Abenomics push persists.

(1) E.g. Newspaper Yomiuri, 9 November 2014
Naruki Nakamura

Head of Fixed Income Japan

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