TOKYO – Market Reactions to Leadership Changes in Japan

The recent surge in Japanese stocks, reaching record highs this week, has been accompanied by a noticeable underperformance in the banking sector. This seems to stem from investors reassessing their positions in light of Sanae Takaichi’s potential as Japan’s new leader.

There’s speculation among analysts that this trend won’t last and that Takaichi’s economic strategies could invigorate public finance. The markets are particularly interested in her support for fiscal stimulus and monetary easing, which, while likely beneficial for stocks, might delay the anticipated interest rate hikes from the Bank of Japan and affect future revenues for banks.

Interestingly, despite the challenges faced by the banking sector, the TOPIX Bank Index saw a slight decline of 0.12%, contrasting sharply with the Nikkei Stock Average’s impressive climb of 4.75% on Monday. It’s worth noting that, overall, the bank stocks have seen a substantial rise of 47% since the Bank of Japan moved away from its stimulus program last March, significantly outpacing the 21% increase in the Nikkei during the same timeframe.

Analysts believe that banks could emerge as key beneficiaries again, driven by expansionary policies that necessitate increased lending. Moreover, a rapidly weakening yen might push the Bank of Japan to reconsider interest rates, despite Takaichi’s more dovish perspective.

This scenario could foster further growth for banks, especially given Japan’s gradual exit from deflationary periods and the end of ultra-low interest rates, which have led to record profits and soaring stock prices for the banking sector. As financial analyst Makoto Kuroda from Goldman Sachs noted, both regional banks and megabanks could thrive under a comprehensive expansion strategy focused on economic security.

Takaichi’s Focus on Economic Security

Takaichi’s recent press conference post-election emphasized economic security through investments in large-scale energy infrastructure and defense, which are likely to need substantial project financing. Kuroda also highlighted that Takaichi aims to revitalize rural economies, which could boost demand for local banking expertise.

Over recent years, as a result of negative interest rates, banks have adapted their business models to rely less on domestic lending spreads. According to Mitsubishi UFJ Financial Group, Japan’s largest financial institution, the anticipated annual increase in pre-tax profit due to a rate hike in January 2025 is projected at 166 billion yen ($1.09 billion)—a figure that, while notable, pales in comparison to last fiscal year’s record of 1.86 trillion yen.

Kuroda mentioned that the impacts of previous rate increases haven’t been fully factored into current earnings, suggesting room for adjustments in long-term strategies and return on equity targets.

The Central Bank’s Stance

Despite Takaichi’s previous hesitations about raising rates, analysts argue that there might be limited capacity to sway the Bank of Japan’s decisions. Historically, while the bank operates independently, it tends to be affected by political changes. Governor Kazuo Ueda recently reiterated a commitment to continue raising interest rates if economic and price conditions remain favorable, despite having not altered his policy stance in response to the new administration.

With Ueda’s term still running for another two and a half years, there seems to be a degree of resilience in the bank’s approach. Takaichi has also been careful in her public statements, asserting that she doesn’t plan to exert influence over the central bank. Regardless, the recent depreciation of the yen—approximately 3.5% since the start of the week—could trigger adjustments, particularly if it breaches the 160 yen to the dollar threshold, which could prompt considerations to raise interest rates to stabilize the currency.

Moreover, questions linger about the feasibility of Takaichi’s plans, especially since a parliamentary majority is not in her favor, thereby relying on coalition partners for legislative support. She will also have to navigate interactions with the Treasury to secure funding.

As Smith from CLSA commented, the Treasury holds significant power, and the effectiveness of Takaichi’s leadership remains uncertain. It may be overly optimistic to believe that the government can drastically increase spending at this point.

(1 dollar = 152.9600 yen)