The intensifying competition between the ruling and opposition parties over tax cuts has raised concerns about fiscal deterioration.

Key Chapter Title List

1. Political Vacuum and Election Prospects
2. Competition Between Ruling and Opposition Parties on Consumption Tax Cut Pledges
3. Responsible Proactive Fiscal Policy and the Lack of Funding Sources
4. Financial Market Reaction: Selling Japan Trend
5. Bond Market Yield Rise and Term Structure Analysis
6. Bank of Japan's Policy Dilemma and Yen Depreciation Risk
7. Characteristics Shift from Benign to Malignant Interest Rate Rise
8. House of Representatives Seat Composition and Ruling Coalition Prospects

Document Introduction

This report focuses on major developments in Japanese politics in late January 2026. At the opening of the ordinary Diet session convened by Prime Minister Sanae Takaichi on January 23, the intention to dissolve the House of Representatives was formally indicated. The election schedule is expected to be: announcement on January 27 and voting on February 8. Although this move has been criticized for creating a political vacuum during the House election period, the prevailing view is that the Prime Minister aims to hold the election while cabinet approval ratings are still high to consolidate the power base and secure just enough additional seats to maintain a slim majority. However, the newly formed centrist reform coalition between the Constitutional Democratic Party and Komeito has complicated the electoral landscape. The Liberal Democratic Party may face a tough battle due to the loss of stable support from Komeito's voter base, significantly increasing the difficulty of assessing the political outlook.

The core policy competition in this election revolves around the reduction of the consumption tax. Both ruling and opposition parties are rushing to include consumption tax cut plans in their campaign pledges. Prime Minister Takaichi, who advocates for responsible proactive fiscal policy, has proposed a plan to reduce the consumption tax rate on food to zero and maintain it for two years. The key issue is that none of these tax cut proposals have been accompanied by prior discussion of clear funding source guarantees, raising deep market concerns about the potential acceleration of Japan's fiscal deterioration. The disconnect between policy promises and fiscal discipline constitutes the primary source of current political and economic risk.

The reaction of financial markets directly reflects these concerns. Some market movements have been interpreted as a "selling Japan" trade. Specifically, bond market yields rose across the board this week, particularly in the ultra-long-term bond sector, which is especially sensitive to fiscal risk. On January 20, 2026, the yield on 10-year Japanese Government Bonds reached 2.3%. The report points out that the interest rate rise observed so far has been primarily viewed as a benign rise driven by expectations of rate hikes supported by a wage-price virtuous cycle. However, it is crucial to be vigilant, as the recent rise increasingly exhibits characteristics of a malignant rise driven by concerns over fiscal deterioration.

Faced with rapidly rising yields, the Bank of Japan is caught in a policy dilemma. The report analyzes that the Bank of Japan finds it difficult to intervene forcefully to suppress the rise in interest rates, as such actions could trigger additional yen depreciation pressure. In this environment, interest rates are expected to continue facing upward pressure in the short term. This analysis incorporates the complex impact of political decisions on market expectations and central bank policy space. The report visually presents the seat foundation of the ruling coalition (LDP/Japan Innovation Party) and the market evolution of long-term interest rates through a House of Representatives seat composition chart (as of November 28, 2025) and a long-term trend chart of 30-year government bond yields, providing key data support for professional readers to assess the linkage between political risk and financial risk.