The ruling LDP-led coalition lost its majority in the lower house election on Sunday. 

Prime Minister Ishiba may face pressure to resign, although initial comments to the press signalled his intention to form a government.

Media reports suggest the Diet may convene for an extraordinary session on 7 November to name the PM. This leaves little time to challenge Ishiba’s position. 

The most likely outcome is for the LDP and Komeito to expand the coalition, either formally or on a supply-and-confidence basis, to a third party such as the DPP or Nippon Ishin. The government would be able to pass legislation on an issue-by-issue basis.

While such a coalition is unlikely to trigger major policies reversals, there is a risk of more expansionary fiscal policies to appease any new coalition partner. The authority of the government will also inevitably become more fragile, increasing political and policy uncertainty ahead of upper house elections next year. 

A tail risk is that the opposition Constitutional Democratic Party (CDP) tries to form a minority government. This could have bigger consequences, given its pushback on Bank of Japan normalisation and proposals to change the inflation target. 

Japanese assets may face some near-term volatility while the political developments unfold. But the dominant drivers remain the corporate reform story, US-Japan rate differentials, and the US election. 

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