By Yasuhiko Seki

TOKYO (MNI) – While expectations for a pro-growth government
spurred yen weakness and stock gains on Thursday, Japanese government
bond investors are now shifting their focus to the post-election
political landscape, looking at downside risks stemming from such a
power shift.

The main opposition Liberal Democratic Party may beat the ruling
coalition led by the Democratic Party of Japan in parliamentary
elections on Dec. 16, which could trigger a spike in bond yields, but
analysts said such a risk may not be as high as feared.

In a rare announcement during a parliamentary debate, Prime
Minister Yoshihiko Noda said on Wednesday that he would dissolve the
lower house of the Diet on Friday and call a snap election if the main
opposition parties agreed to his plan to cut parliamentary seats

Noda plans to call a lower house parliamentary election on Dec. 16
after the LDP and New Komeito said they will back up the Diet reform
which Noda said is necessary before asking the public to bear higher
costs of living arising from a planned sales tax hike.

Election campaigns will officially begin on Dec. 4, media reports
said.

“Assuming that the emergence of an LDP-led government will trigger
a weak yen and higher share prices, JGB players may have to adjust their
views on short-term interest rates, too,” said Akito Fukunaga, chief
rate strategist at RBS Securities Co.

“This change of perception may send 10-year JGBs toward 0.8% before
the actual election takes place,” he said.

The benchmark 10-year JGB yield was 2.0 basis points higher at
0.755% on Thursday morning.

The Nikkei 225 Stock Average finished the morning session 0.96%
higher, thanks to the notion that a weaker yen will support exporter
profits, and thus the overall economy.

The yen softened to Y80.31 against the dollar on Wednesday, the
weakest level since Nov. 6, in an immediate reaction to remarks by Noda
that he would dissolve the lower house on Friday.

Noda, like his predecessor Naoto Kan, has put a higher emphasis on
rebuilding the nation’s finances through a sales tax hike in order to
quell fears about the fate of public pensions and medical services,
instead of seeking to raise general tax revenues by boosting growth with
fiscal programs

By contrast, right-wing politician Shinzo Abe, who became the
leader of the LDP in September, has said he would try to fix the
flagging economy before tackling the debt issue.

Investors and analysts are also watchful of what political parties
will win the elections and what policies they will form, either
single-handedly or in a coalition.

“The key focus is on with which parties the LDP is going to form an
alliance, which is likely to affect the size of any supplementary
budget,” said Chotaro Morita, chief strategist at Barclays Capital
Securities Co.

“If the LDP were to ally with those DPJ politicians who were
involved in a three-party agreement last summer, the basic
macro-economic policies, including a sales tax hike, won’t change
drastically, thereby making any supplementary budget to be relatively
small,” he said.

In August, the DPJ, the LDP, which was then led by former finance
minister Sadakazu Tanigaki, and New Komeito agreed to double the 5%
sales tax by 2015 in two stages and improve social security services on
condition that the economy continues to recover steadily.

“But if the LDP were to form a coalition government, jointly with
those who are willing to spend more in order to pull the Japanese
economy out of the slump and ask the Bank of Japan to do more, it may
increase the risk of a spike in JGB yields toward 0.8% and beyond,”
Barclays’s Morita said.

“The focus on a supplementary budget will be whether is scale will
reach Y10 trillion to Y15 trillion, or even higher, as the JGB market is
most likely to be able to absorb as long as the size comes in between Y1
trillion and Y5 trillion,” he said.

Meantime, RBS’s Fukunaga also notes the best case scenario for the
Japanese economy would be to have a grand coalition government,
comprising the LDP, New Komeito and DPJ policymakers who were involved
in the three-party agreement.

“If a strong government emerges in a way that will control not only
the lower house but also the upper house, it should prove to be most
positive for the Japanese economy but the most negative for the JGB
market,” he said.

“If this turns out to be the case, I wouldn’t be surprised if
10-year JGB yields climbed toward 1.1%,” Fukunaga said.

“On the other hand, if the LDP wins the next general election but
fails to change the hung parliament, 10-year JGBs may trend back toward
a 0.5% to 0.8% range,” he said.

While the emergence of an LDP-led government is widely expected to
yield downside risks to the JGB market, analysts downplay the
significance of a possible power shift in the longer-term.

“It makes almost no sense to set a CPI growth target of 3% as a
realistic policy goal, given Japan’s economic structure, but it can only
be used as a tool to pressuring the BOJ to take additional easing
action,” said Kazuhiko Sano, chief strategist at Tokai Tokyo Securities
Co.

Abe recently said the Bank of Japan should continue to ease
monetary policy until annual consumer inflation rises to 3% from
around zero now, much higher than the BOJ’s interim goal of achieving 1%
inflation in the longer term.

“More importantly, even if the LDP manages to get more from the
BOJ, monetary policy alone won’t be able to boost inflation expectations
in Japan,” Sano said.

“So the current JGB yield levels turn out to be fair, regardless of
what parties win the general elections,” he said.

Yields on 10-year JGBs finished up only 0.5 basis points at 0.755%
on Thursday morning.

Some analysts also note that the outcome of the Dec. 16 elections
will have only a limited impact on the JGB market not only in the long
run but also in the near term.

“Developments in negotiations on (how to avert) the fiscal cliff in
the U.S. should dominate 70% to 80% of the direction of the JGB market
at least before the elections, with a compromise during the talks seen
prompting a spike in bond yields both in the U.S. and Japan,” Morita
said.

–email: yseki@mni-news.com
–email: msato@mni-news.com

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