On 8 February, Japanese voters gave the Liberal Democratic Party (LDP) and Prime Minister Sanae Takaichi a clear win. This result gives her the freedom to move forward with her security plans and increased government spending.
Tokyo stocks have risen by 14% since the start of the year, but bond investors remain cautious.
The Prime Minister called early elections after dissolving the House of Representatives on 23 January, aiming to use her high approval ratings to win a strong majority in parliament.
Almost 68% of Parliament’s seats
The strategy worked well. The LDP won 316 out of 465 seats, up from 191 in the 2024 election.
The LDP now has a large enough majority to pass laws without help from smaller parties.
With over two-thirds of the seats, the LDP can even change the constitution and does not have to worry about opposition vetoes from the other chamber.
The Prime Minister’s plan focuses on three main goals: boosting Japan’s military, making migration rules stricter, and increasing government spending.
Persistent reliance on fiscal stimulus
“We must move Japan away from an excessively strict fiscal policy and from underinvestment.” With this statement, Sanae Takaichi shows she plans to raise public spending, even though past stimulus efforts have already pushed Japan’s public debt to 230% of GDP.
To help households facing higher prices, the government plans to suspend the 8% tax on food for two years. There are also plans for income tax cuts and possible lower energy taxes to support people’s buying power.
The government also plans incentives to encourage companies to invest in key areas like semiconductors, artificial intelligence, shipbuilding, biotechnology, and cybersecurity.
These plans have pushed Tokyo stocks to new highs. More government spending could help the economy in the short term, but it may also weaken public finances and the yen. A weaker yen makes overseas earnings of Japanese companies worth more, which boosts stock prices.
Market optimism faces constraints
The current excitement in the stock market may face political and financial limits. Ironically, because the Prime Minister no longer needs to please smaller coalition partners, she might actually spend less.
Even within the LDP, not everyone agrees on more government spending. Some senior members want a balanced approach and think any extra spending should be matched by cuts elsewhere.
If the government spends too much, the yen could weaken further, making imports more expensive and hurting household budgets - the very problem the election promises aim to fix.
If internal opposition does not limit spending, financial markets might. Higher public debt could raise worries about long-term stability. Long-term interest rates, already at their highest since the 1990s, may keep rising, showing that Japan’s period of very low borrowing costs is over.
New geopolitical and structural risks arise
Besides fiscal issues affecting the bond market, nationalist policies could create more economic challenges.
Japan’s relationship with China has already worsened. Beijing has told its citizens, who make up 30% of Japan’s tourism revenue, not to travel there. China has also banned exports of goods that could have military uses, which may affect many Japanese industries.
These diplomatic tensions are a real risk to Japan’s economy in the near future.
In the long run, tougher migration rules could make Japan’s existing labor shortages even worse.
So, the recent rise in Japanese stocks should be seen with caution, as it is based on short-term factors. In the medium to long term, the new policies do not fix Japan’s deeper problems, like high debt and an aging population.
Because Japan’s growth outlook is limited and stocks have already performed well, we are not buying Japanese equities. Yen-based bonds also do not look appealing, since interest rates are expected to rise. Check our balanced portfolio for other investment ideas.