Markets Focus

Yen weakens on Takaichi victory

Sanae Takaichi won the Liberal Democratic Party (LDP) leadership election held on 4 October. The race, which was announced on 22 September, was contested through votes from both party and Diet members. Media surveys had indicated that Shinjiro Koizumi was in the lead, followed by Takaichi in second place and Yoshimasa Hayashi in third, who was reportedly closing the gap. However, Takaichi ended up gaining a strong lead over Koizumi in the party member vote, which influenced Diet members in the runoff. Takaichi is expected to begin full-scale party appointments early next week and start talks on forming a coalition or cooperation with opposition parties. She is likely to be nominated as prime minister at the extraordinary Diet session convened on 15 October. The unexpected victory by Takaichi, which overturned prior expectations, pushed the USD/JPY up by around two yen in early trading on 6 October to around 149.50.

Takaichi says government should take responsibility for fiscal and monetary policy

Takaichi has long advocated expansionary fiscal policy and a preference for accommodative monetary policy. During the recent upper house election, she called for a temporary consumption tax cut as a measure against rising prices, a stance that could be described as relatively close to that of opposition parties. Her remarks on monetary policy during last year's leadership race, including comments such as "raising rates is foolish," also drew attention. However, she moderated such positions to some extent in this election. Her shift toward a more centrist stance likely contributed to her victory. Even so, she has repeatedly said "the government should take responsibility for fiscal and monetary policy," indicating that these areas remain among her key priorities. This suggests some degree of correction toward the policy direction she has previously advocated.

Concerns over fiscal expansion weigh on bonds and the yen

Takaichi has pledged "responsible expansionary fiscal policy." In debates during the leadership election, she acknowledged the importance of fiscal discipline. She has toned down her position calling for a review of the consumption tax made during the upper house election, noting that technical challenges make immediate implementation difficult. However, she said a consumption tax cut was not off the table at her press conference on 4 October and cited her top priorities as the abolition of the former provisional tax rates on gasoline and diesel, as well as an increase in the basic income tax deduction. Fiscal spending could increase further as she explores forming a coalition or coordination with opposition parties, or during the process of drafting a supplementary budget. During the upper house campaign, she was the only one among the five candidates to say that additional issuance of deficit-financing JGBs would be acceptable if necessary. Taking this into account, financial markets are likely to remain focused for the time being on the risk of fiscal deterioration. Upward pressure on superlong JGB yields intensified during the upper house election, and the yen tended to move in tandem. Bond prices could fall further over time, driving renewed yen weakness if the Takaichi administration moves to implement the expansionary fiscal policies that she had talked down during the leadership race.

BOJ may be forced to reassess path of monetary policy normalization

Takaichi appears unlikely to fully endorse the current path toward monetary policy normalization. She has not repeated last year's remark that "raising rates is foolish," but during the leadership race she said the government should determine the direction of monetary policy. At her press conference on 4 October, she described demand-pull inflation as ideal, hinting at a negative stance toward near-term rate hikes under cost-push inflation. She also referred to a possible review of the Joint Statement released by the government and the BOJ in January 2013. Given that twelve years have passed since its signing and economic conditions have changed significantly, the need for a review has been raised repeatedly, so her comments were not unexpected in that sense. However, taken as a whole, her statements suggest that such a review could potentially limit the BOJ's operational independence or remove references in the current statement to the government's fiscal efforts.

In last month's monetary policy meeting, policy board members Hajime Takata and Naoki Tamura opposed maintaining the status quo and proposed resuming rate hikes. A subsequent speech by Asahi Noguchi also suggested readiness to restart hikes. The October Tankan confirmed generally solid business sentiment, and the branch-manager hearing information compiled through the meeting on 6 October was expected to support preparations for a rate hike resumption. The return of a prime minister who declares that monetary policy will be government-led makes it uncertain whether the path to normalization built by BOJ Governor Kazuo Ueda to date can be sustained. A rate hike resumption at the end of the month now appears unlikely. Expectations for a resumption of rate hikes had been growing since last month's meeting, which had lent some yen-buying momentum, but that was quickly unwound in early trading on 6 October.

Yen weakness likely to persist if rate hikes prove difficult

We expected the BOJ to resume rate hikes at the end of this month and return to a cycle of roughly one hike every six months, leading to a corresponding gradual decline in the USD/JPY. We have been forced to reassess that scenario given the diminished prospect of a near-term rate hike. Takaichi's remarks point to policies that encourage yen weakness, and we see little to challenge that view. The surprise outcome of the leadership election suggests the USD/JPY could rise to around 150 as an initial reaction based on current levels. The pair could test higher levels if it breaks above 150 once the direction of fiscal and monetary policy becomes clearer, even with the broader dollar trend turning softer. The yen is unlikely to strengthen beyond the recent trading range in the remaining three months of the year.

Ultimately, risk remains that the BOJ will be forced to raise rates

The LDP now holds a minority position in both chambers of the Diet, and the outlook for maintaining a coalition with its partner Komeito or forming alliances with other opposition parties remains uncertain, making policy management difficult. After the nomination of the prime minister at the extraordinary Diet session and the finalization of a supplementary budget, the new year could bring shifts in the administration's perspective. On the monetary policy front, we think the BOJ will eventually be pushed toward rate hikes. Both the recent upper house election and the current LDP leadership race focused heavily on measures to counter rising prices, which Takaichi also identifies as her top priority. Yen depreciation is already recognized as one of the key drivers of cost-push inflation, and that weakness stems in part from continued monetary easing amid inflation, with negative real interest rates. Further yen depreciation ahead may provide temporary support for exporters impacted by US tariff policy, but it would also prolong cost-push inflation. In that environment, even though rate hikes would not be enough to contain inflation, they could gain acceptance as a necessary condition for curbing it.

In addition, US President Donald Trump is scheduled to visit Japan at the end of this month, and Washington has been pressing Japan to raise rates as part of broader currency policy discussions. The US Treasury's Macroeconomic and Foreign Exchange Policies of Major Trading Partners of the United States explicitly states that the BOJ should maintain a tightening stance, and Treasury Secretary Scott Bessent has openly said that the BOJ is behind the curve. Japan is unlikely to be labeled a currency manipulator, but under the current conditions, where tariffs are effectively being used as leverage, it may prove difficult to continue resisting external pressure.

The BOJ's outlook assumes inflation will slow below 2%, but if that does not occur, regardless of the reason, the conclusion may again be that a rate hike is necessary. Once that debate takes shape, the yen could strengthen sharply at times, marking a phase in which yen weakness begins to ease. Volatility is therefore likely to increase after the start of the new year.

QUARTERLY FORECAST RANGE AND PERIOD-END FORECAST（Changes are highlighted in red）

Our forecast range estimates the high and low for each quarter. The period-end forecast is our forecast for USD/JPY at 17:00 New York time at the end of each quarter.

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