Japan's Policy Crossroads: Takaichi's Fiscal Boldness vs. BOJ's Rate Hike Uncertainty

Japan's financial markets experienced a seismic shift following Sanae Takaichi's surprise victory in the Liberal Democratic Party (LDP) leadership race, positioning her to become the country's first female prime minister. The Nikkei 225 surged to a record intraday high above 48,100, while the yen weakened to a six-month low of 153.22 per U.S. dollar, reflecting heightened expectations of expansionary fiscal and monetary policies. Takaichi, a staunch advocate of "Abenomics" principles, has signaled opposition to immediate Bank of Japan (BOJ) rate hikes and support for increased government spending, triggering what analysts term the "Takaichi trade"-a combination of long equity positions and short yen exposure. The yen's decline accelerated after Takaichi's victory, with the USD/JPY pair rising over 3.5% in three days, driven by speculation that the BOJ will delay normalization of monetary policy.

The market's re-pricing of Japan's policy outlook has created a divergence between fiscal and monetary strategies. Takaichi's pro-stimulus agenda, including potential tax cuts and infrastructure investments, has raised concerns about inflationary pressures and fiscal sustainability. The yen's weakness, meanwhile, has bolstered Japanese exporters, with sectors like artificial intelligence, semiconductors, and defense seeing sharp gains. Mitsubishi Heavy Industries, a key defense contractor, rose over 11%, while Japan Steel Works surged more than 15%. However, the yen's decline has also reignited debates over its competitiveness implications. U.S. President Donald Trump has previously criticized Japan's currency policy, and analysts warn that prolonged yen weakness could strain bilateral trade relations.

The BOJ faces a delicate balancing act. While Takaichi's victory initially reduced the market-implied probability of an October rate hike from 68% to 41%, inflation remains above the central bank's 2% target, and real wage growth remains stagnant. Former BOJ official Takahide Kiuchi noted that the central bank may still hike rates in December to counter imported inflation, despite Takaichi's advocacy for monetary easing. This uncertainty has led to a flattening of the yield curve, with two-year Japanese government bond (JGB) yields falling while long-term yields rose to 3.29%, a 34-year high. The BOJ's credibility is under scrutiny, with some analysts suggesting that prolonged dovishness could undermine its independence and exacerbate inflation risks.

Global macroeconomic dynamics further complicate the outlook. The U.S. dollar remains strong against the yen, supported by a 244-basis-point yield differential between U.S. and Japanese 10-year bonds. Carry trades involving the yen have intensified, with USD/JPY reaching 152.98 on October 9, near levels last seen in February 2023. Technical indicators suggest continued upward momentum for the dollar-yen pair, with key resistance levels at 153.00 and 155.00, the latter of which has historically prompted intervention by Japanese authorities. Market participants are also monitoring the U.S. government shutdown and Federal Reserve policy, which could influence the dollar's trajectory and, by extension, the yen's performance.

Takaichi's leadership presents both opportunities and challenges. While her fiscal stimulus could provide a near-term boost to growth, structural issues-such as Japan's aging population and high public debt-remain unresolved. Analysts caution that her ability to implement policies will depend on forming a stable coalition government, as the LDP currently lacks a majority in the lower house. The upcoming BOJ policy meeting on October 30 and Takaichi's cabinet appointments will be critical in shaping market expectations. If the yen continues to weaken beyond 155, intervention by Japan's Finance Ministry or verbal warnings from officials could emerge, as seen in previous episodes of currency volatility.

[1] Reuters, (https://www.reuters.com/world/asia-pacific/market-analysts-reaction-takaichi-becoming-next-japan-pm-2025-10-06/)

[2] CNBC, (https://www.cnbc.com/2025/10/09/the-takaichi-trade-dilemma-japan-currency-tightrope-with-trump-abenomics.html?msockid=3f36289023aa62192e1f3e1122f363b8)

[4] Bloomberg, (https://www.bloomberg.com/news/articles/2025-10-05/yen-falls-after-takaichi-win-japan-stocks-may-get-boost)

[5] New York Times, (https://www.nytimes.com/2025/10/05/business/japan-stocks-yen-takaichi.html)

[6] EBC, (https://www.ebc.com/forex/usd-jpy-will-japan-s-policy-shift-narrow-the-yield-gap)

[9] Bloomberg, (https://www.bloomberg.com/news/articles/2025-10-09/yen-s-rapid-fall-complicates-takaichi-hopes-for-slower-boj-hikes)

[10] Forex.com, (https://www.forex.com/en-us/news-and-analysis/usd-jpy-eur-jpy-outlook-boj-caution-and-fed-signals-keep-yen-under-pressure/)

[11] Business Times, (https://www.businesstimes.com.sg/international/global/japans-stocks-zoom-yen-slumps-takaichi-win-dims-boj-hike-bets)