Commentary: Japan’s Political Turmoil Puts Markets on Edge

Japanese Prime Minister Shigeru Ishiba announced his resignation on September 7, citing a desire to prevent internal conflict within the ruling Liberal Democratic Party (LDP). This decision follows electoral setbacks, with the LDP-led coalition losing its majority in the House of Representatives in October 2024 and the House of Councilors in July 2025. These losses triggered significant pressure from inside the party, with several cabinet ministers publicly advocating for an accelerated leadership contest. NHK interviews revealed that over 130 of the LDP’s 295 Diet members support moving up the party presidential election. Facing such mounting pressure, Ishiba chose to step down rather than risk deeper intra-party divisions[para. 1].

The LDP is expected to initiate its presidential election process imminently. The official timeline is to be announced on September 8, and candidate registrations will open thereafter. Candidates will campaign for one to two weeks before voting. The election process involves both Diet members and local party representatives; if no candidate achieves a first-round majority, a runoff is held among Diet members and prefectural chapter representatives. The election winner becomes the new party president and is formally confirmed as Japan’s next prime minister. The two leading contenders are Sanae Takaichi, a conservative with high poll ratings and strong factional support, and Shinjiro Koizumi, the current Minister of Agriculture and son of former Prime Minister Junichiro Koizumi. While Takaichi possesses greater party backing, Koizumi enjoys broad popularity among grassroots voters. Polls show Takaichi and Koizumi virtually tied, with 23% and 22% respective support[para. 2].

The political situation in Japan remains fluid in the short term, increasing the risk of market volatility. Historically, the LDP expedites its leadership selection when unexpected vacancies occur, aiming to restore stability. The current transition period is expected to last until late September or early October, with the new prime minister likely in office by October. However, during this transition, heightened factional maneuvering could fuel further instability and market swings. If Takaichi wins, her policies favoring increased fiscal stimulus and defense spending may boost Japanese equities and the yen, while putting upward pressure on Japanese government bond yields[para. 3].

Regarding fiscal policy, the incoming administration is anticipated to continue a loose fiscal approach, though the extent will depend on who wins. Having lost majorities in both Diet chambers, the LDP will need at least some opposition support to pass the 2025 supplementary budget and the 2026 budget. This political reality may force the ruling coalition to accept opposition demands, possibly involving consumption or gasoline tax cuts. Both major parties support fiscal expansion to address the challenge of elevated inflation, but Takaichi’s leadership would likely result in more aggressive stimulus than Koizumi’s[para. 4].

For monetary policy, another Bank of Japan (BOJ) rate hike by year-end remains the base-case scenario, but worsened political uncertainty could delay action. The BOJ is expected to adopt a cautious, dovish approach at its September 19 meeting, given the fragile political climate. Nonetheless, with inflation remaining high (August CPI up 2.7% year-over-year, core CPI up 1.5%), and real rates in negative territory, pressure to tighten remains. Fiscal expansion following the LDP election could further stimulate inflation, forcing the BOJ to consider another rate increase before year’s end. Ongoing inflation, fiscal stimulus, and political uncertainty are likely to raise risk premiums and push up long-term government bond yields further[para. 5].

[para. 1]