The Japanese yen dropped to a three-month low on Monday, weakening by as much as 0.8% against the US dollar, as markets reacted to election results showing Japan’s ruling coalition, led by the Liberal Democratic Party (LDP) and its partner Komeito, failing to retain a majority in the lower house. This currency depreciation marked the yen’s fifth straight weekly decline, rekindling concerns over potential market intervention by Japanese authorities to stabilize the currency.
In contrast, Japan’s equity markets defied the political uncertainty, with both the Nikkei 225 and the broader Topix index reversing early losses to post gains of over 1%. While political turmoil usually unsettles investors, analysts suggest the weakened yen has provided unexpected support for stocks, especially export-heavy sectors that benefit from a cheaper currency.
Japan’s lower house election results left the LDP and Komeito without the 233 seats required for a majority, prompting questions about Prime Minister Shigeru Ishiba’s ability to maintain stability in the government and advance his policy agenda. The close election outcome has led analysts to warn of potential gridlock in legislative processes. Tim Waterer, chief market analyst at KCM Trade, cautioned that the uncertainty could lead to “a quagmire regarding the legislative process—a scenario which may not bode well for the yen and the Nikkei, at least in the short term.”
Political analysts note that Ishiba still stands a chance to garner enough support to stay in power, though his administration may face challenges in advancing legislation. The market’s surprisingly positive response on Monday suggests that investors might anticipate stability if Ishiba can consolidate backing, particularly as the yen’s depreciation tends to benefit Japan’s large export sector.
“This is an unexpected reaction,” remarked Shuji Hosoi, senior strategist at Daiwa Securities. “While political risk may be increasing, there may be expectations that the Ishiba administration won’t become a lame duck immediately.”
The yen’s ongoing slide against the dollar has been one of the most significant among the Group-of-10 currencies, down more than 7% this year. Analysts attribute much of the currency’s weakness to Japan’s persistently low interest rates, a stark contrast to the higher rates in economies like the United States. This interest rate disparity has made the yen less attractive to investors, who can receive higher returns in other major currencies.
Japan’s central bank, the Bank of Japan (BoJ), is expected to maintain its ultra-loose monetary policy in a meeting scheduled for later this week. Market participants widely anticipate that the BoJ will keep its policy interest rate unchanged, reinforcing the yen’s low-yield status. The yen traded at 153.58 against the dollar on Monday morning in Tokyo, edging closer to the July low of 161.95, which remains the weakest point of the year.
Atsushi Mimura, Japan’s top currency official, issued a warning last week, signaling the government’s increased vigilance over the yen’s performance. Mimura noted that authorities are closely watching currency movements, reflecting heightened concern over the yen’s depreciation. If the yen continues its downward trend, some experts suggest that Japan’s Ministry of Finance may consider intervention to prevent excessive weakening.
Japanese equities have struggled in recent months after reaching record highs in July. The market pullback reflects a mix of global economic concerns and the yen’s continued decline. While international investors might typically view political instability as a negative force, some believe that the current situation could ultimately benefit the markets if the LDP-led coalition can retain influence despite the setback.
Gary Dugan, CEO at Global CIO Office, stated, “Markets would prefer the current coalition to win through. International investors just want to see the corporate sector continue on a path of restructuring without any noise from politics.”
Japan’s corporate reforms, which have focused on return on equity (ROE) and increasing corporate capital expenditure, have been a key driver of stock market performance in recent years. Alex Cousley, an investment strategist at Russell Investments Group, argued that the market’s optimistic outlook is justified due to Japan’s continued corporate reform initiatives. “The work on corporate reform, focus on ROE, and increasing capital expenditure by corporates are all still very encouraging, and shouldn’t be impacted too heavily by the election outcome,” Cousley said.
However, some analysts caution that political deadlock could hinder economic policies. Nicholas Smith, strategist at CLSA Securities Japan Co., noted that Ishiba’s desire to increase taxes could face greater resistance if the LDP’s influence wanes. “The weaker the LDP is, the harder it is for him to achieve that, which is good for markets,” said Smith, suggesting that opposition to tax hikes could be a relief for investors concerned about additional corporate burdens.
As the yen’s slide accelerates, the Japanese government is under pressure to address the currency’s weakness. While currency depreciation can be favorable for exporters, a steep and rapid fall can lead to rising import costs, affecting domestic consumers and businesses reliant on imported goods. Japan imports a significant portion of its food and energy, and a weaker yen makes these essentials more expensive, thereby impacting inflation and consumer purchasing power.
Currency intervention remains a possible tool for the government, though Japan’s authorities have been cautious about entering foreign exchange markets. Past interventions have been rare, as Japan usually allows the yen to fluctuate with market forces. However, in recent months, officials have hinted that intervention may be considered if the currency continues to fall at its current pace.
A recent report by the Ministry of Finance emphasized that currency stability is a priority for Japan’s economic health. With the yen nearing the psychologically significant 160 level, some analysts argue that intervention may be imminent. An intervention could include direct buying of the yen to prop up its value or coordinated action with other central banks.
Japan’s economic landscape faces numerous challenges, from an aging population to sluggish wage growth, which has impacted domestic consumption. A weaker yen, while favorable for exports, also raises the cost of imports, potentially putting pressure on inflation. Japan’s inflation rate has seen moderate increases but remains below the central bank’s target of 2%, prompting policymakers to maintain a low interest rate environment.
This combination of low interest rates and rising import costs could create a complex economic scenario for Japan, especially if the yen’s weakness continues. The Bank of Japan’s upcoming policy meeting will be closely watched, as any hints of policy adjustments could influence currency movements. However, most analysts agree that a significant rate increase is unlikely, as Japan’s economy is still recovering from the impacts of the COVID-19 pandemic and faces structural challenges.
As Japan enters a period of political recalibration, investors are bracing for potential fluctuations in both the yen and the stock market. The outlook for Japanese equities remains cautiously optimistic, given that corporate reforms and favorable export conditions are likely to persist. However, the uncertain political landscape and the yen’s ongoing decline pose risks.
Analysts suggest that if Ishiba’s government can stabilize and pursue pro-business policies, the markets may experience a smoother path forward. A stronger political mandate could enable the government to pass legislation supporting corporate growth and economic reform, benefiting both domestic and foreign investors. Conversely, prolonged political gridlock could lead to volatility, especially if opposition parties attempt to derail pro-market policies.
In the coming weeks, investors will closely monitor any statements from Japan’s Ministry of Finance and the Bank of Japan for indications of currency intervention or policy shifts. The BoJ’s commitment to low interest rates is a double-edged sword—supporting growth on one hand but pressuring the yen on the other. As a result, Japan’s economic policymakers face the complex task of balancing currency stability with the need for economic recovery and growth.
