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As the 27 September contest to decide the next president for Japan’s Liberal Democratic Party (LDP, the country’s ruling party) draws nearer, market participants, who had seemingly ignored the contest until its eve for the most part, have gone from cold to lukewarm in terms of interest in the race. This is despite the fact that the winner of the race will also become the next prime minister replacing the incumbent Fumio Kishida. There is one major thing to keep in mind going into the upcoming LDP leadership contest—that a general election is scheduled to be held in Japan by October 2025 at the latest. The ruling party’s chief concern is to select a candidate who can prevail at the general election. This makes the candidacy of an incipient LDP leader more of a marathon than a sprint.

Meanwhile, apart from the obvious stigma imposed upon the incumbent LDP leadership by the political funding scandal that came to light in 2023, it may be said that the Kishida administration’s policies have assisted in helping Japan to emerge from decades of deflation without inviting concern that such policies hinged on unsustainable spending. These include appealing to foreign investors by embracing governance reforms, putting cash to work in capital markets with the “new NISA” reforms, plus investment in strategic areas such as digital transformation (“DX”), decarbonisation (“GX”) and an increase in defence spending. The policy mix, while not necessarily resulting in stringent fiscal restraint, has been mostly successful in harnessing growth to achieve a path back toward primary balance surpluses. Moreover, territorial tensions with China aside, the Kishida administration’s relations with Asian neighbours as a whole appear to represent an improvement in comparison to those of administrations immediately prior.

Are any of the nine (or perhaps more importantly, the leading three) candidates for LDP leadership likely to drastically overturn these policies? We believe they have limited incentive to do so. First of all, the slow-moving mechanisms of Japanese policy-making most likely inhibits this type of radical shift from a technical standpoint.

Secondly, given the new LDP leader’s role is to win a general election, it may be said that campaigning on a platform of radical reform and departure from Kishida’s policy platform (which, aside from the funding scandal, seems mostly to be working favourably) may not be the way to achieve this; rather, it may be said that “less is more” for candidates who wish to represent the LDP.

At present, the payoff for radical reform promises may be limited for LDP hopefuls

Examples of controversies that could be raised with low political payoff come from various candidates – including the top three in terms of popularity in recent polls (former defence minister Shigeru Ishiba, former environment minister Shinjiro Koizumi and economic security minister Sanae Takaichi). For example, hinting at higher taxes on capital may have been construed as in conflict with the tax incentives of the “new NISA” program designed to transform savings into investment (Ishiba). Similarly, Koizumi’s comments about labour market reform may have been needlessly provocative; the benefits associated with introducing controversial reform today may be much lower than simply capitalising on an existing structural trend, particularly the growing labour supply shortages, especially among the more flexible types of jobs. Meanwhile, Takaichi’s claim to successorship of former Prime Minister Shinzo Abe—a long-standing party and national leader—could be viewed as badly timed if accompanied by hawkish regional foreign policies, especially as sluggish growth stokes domestic discontent in China.

Why betting on BOJ political pressure may be a misleading gauge

Meanwhile, in assessing which candidate may be most “market friendly”, it may be simple for the market to favour the candidate most likely to resist the Bank of Japan (BOJ)’s monetary tightening regime. But we believe that such a simplification is naive. This is because what has worked over the past decade may not be as successful in today’s context. This is particularly relevant when considering the recovery period from the double hits of the Global Financial Crisis and the Tohoku disaster, when risk-aversion drove the yen to multi-year highs and Japan’s labour supply shortage had not yet resulted in higher wages due to a surge in labour force participation. All of these factors, present at the start of the Abe administration, with Haruhiko Kuroda at the helm of the BOJ, were uniformly consistent with significant and consistent increases in BOJ stimulus, which in turn was necessary to conquer Japan’s then deflationary mindset.

But things have changed. Perhaps the greatest difference between the current situation and that of the Abe administration is that reflation is now a reality and not a distant hope. At the current juncture, Japan has already experienced two years of above-target core inflation. While some of the motivators of these price rises are slowly subsiding, others have become more structurally entrenched. Keeping inflation in positive territory implies that an autonomous central bank should have the power to respond not only deflationary prospects, but also to inflation potentially overshooting. Undermining the BOJ’s autonomy at this juncture would jeopardise the central bank’s ability to react to any such overshooting.

In advance of a general election, “reading the room” may pay off

In this context, the top candidate for LDP leadership may just be the one who can best “read the room” (or the “air” in Japanese colloquial expression), adapt to changing circumstances and therefore gain support for the general election, while capitalising on all that has started to work in Japan’s favour as it recovers from the pandemic.

The time for candidates to differentiate themselves may come soon enough in the form of a general election (the new prime minister succeeding Kishida is expected to dissolve the Lower House and call a snap election). This would allow the chosen candidate to contrast the LDP’s policies with those of former Prime Minister Yoshihiko Noda, who has just been chosen as leader of Japan’s largest opposition party, the Constitutional Democratic Party.