Political Turmoil in Japan Deepens—"Thick Fog" Over Next Year's Budget and Bank of Japan's Interest Rate Hike Timing

1. What is Happening —— The Shaky Foundation of the Ishiba Administration and the Speculation of an "Early Leadership Election"

Amidst growing calls for resignation from both within and outside the ruling party, the Liberal Democratic Party has begun considering the unprecedented step of advancing the party leadership election based on party rules. This move is driven by consecutive defeats in last year's House of Representatives election and this July's House of Councillors election, which have significantly weakened the administration's centripetal force. If the leadership election is held in September, the new administration can tackle supplementary and budget formulation and external economic policies.

On the other hand, if the decision is postponed, the political vacuum may prolong, significantly increasing the risk of delays in policy decisions. This uncertainty casts a shadow over both the "next fiscal year's budget" and the "timing of the Bank of Japan's interest rate hike."Investing.com

2. Direct Impact on the Budget Formulation Schedule —— Outline Requests, Government Proposal, and Parliamentary Deliberations

Japan's budget formulation follows a tight schedule: the Ministry of Finance compiles the outline requests from each ministry in August, the government proposal is approved by the Cabinet in December, and it must be passed by the Diet before the new fiscal year starts in April. If it is not passed in time, a provisional budget is implemented, potentially delaying public works and subsidy execution.

Recently, the government decided on the "outline request criteria" for the fiscal year 2026, indicating that requests can be up to 20% more than the initial amount of the previous year, with a focus on addressing high prices. The total request amount is expected to continue exceeding 110 trillion yen, and prolonged political uncertainty could complicate adjustments to this "big ball."Investing.comThe Japan TimesNippon

Key Points
・August: Compilation of Outline Requests
・December: Government Proposal Decision
・By Next April: Enactment Before New Fiscal Year, Risk of Provisional Budget if Delayed

3. Timing of the Bank of Japan's Rate Hike —— September? October? December? Or Next Year?

The Bank of Japan is in a phase of exploring an "exit" from the large-scale easing that has continued for over a decade.The next monetary policy meeting is scheduled for September 18–19, followed by meetings at the end of October and mid-December. The deeper the political turmoil, the more likely the central bank is to operate cautiously to avoid "political attention." If a prominent pro-reflation lawmaker rises, the rate hike may be delayed, while a candidate advocating fiscal discipline and normalization could accelerate the timing. Some in the market are factoring in a scenario of a September postponement—with a small resumption of hikes in October, December, or January next year.Investing.comJapan Information OlympicsEquals Money

4. Division within the Ruling Party over "Interest Rate Views" —— Cautious Rate Hike Faction vs. Normalization Advocates

The tug-of-war between political affairs and interest rate normalization is reflected in debates within the ruling party. Veteran Ken Saito has warned against hasty rate hikes, considering the headwinds from U.S. tariff policies and economic fragility. Meanwhile, Taro Kono, seen as a potential next leader, calls for additional rate hikes by the Bank of Japan and the restoration of fiscal discipline, advocating a shift away from the expansionary path of Abenomics. The differences in economic views among candidates have emerged as a focal point in the leadership election, and depending on the outcome, both the budget framework and the Bank of Japan's timetable could shift simultaneously.Reuters+1

5. Policies and Markets by Scenario

Scenario A: Leadership Election in September → New Administration Launch

• The new cabinet quickly adds to supplementary and price measures. The operation of expanding key areas progresses, maintaining the momentum of expenditure expansion.

• Interest rates resume gradually "in October-December" or "early next year." The exchange rate is prone to fluctuations in both yen appreciation and depreciation, but the early resolution of political uncertainty is a factor in reducing volatility.The Japan TimesNippon
  
  

Scenario B: Postponement of Leadership Election → Continued Uncertainty Until Early Next Year

• Budget formulation faces difficulties due to ruling and opposition party conflicts, with risks of delays in supplementary execution and negotiations on the initial budget for the next fiscal year. The possibility of a provisional budget increases.

• The Bank of Japan's cautious stance to "avoid political noise" strengthens, and rate hikes are postponed until after the new year.Investing.com
  
  

Scenario C: Coalition Restructuring and Policy Package Redesign

• The fiscal outline changes with the reconfiguration of taxes, expenditures, and growth investments. The pace of rate hikes also depends on the "policy market view of the new coalition."

• In response to external shocks such as U.S. tariff policies, emergency measures are taken with the total mobilization of supplementary, foreign exchange intervention, and monetary policy.Investing.comReuters

6. Practical Impact on Households and Businesses

• Households: Caught between high prices lowering disposable income and interest rate normalization. Fixed-rate loans are relatively stable, but the risk of increased burden on variable-rate loans needs to be factored in.

• Small and Medium Enterprises: Risk of rising costs for working capital procurement. Delays in the execution of subsidies and grants could affect cash flow, so alternative measures from local government menus should be considered.

• Export Companies: The yen exchange rate is prone to fluctuations due to political and policy schedules. It is urgent to review hedge ratios and strengthen the tariff resilience of supply chains.Investing.com

7. Important Upcoming Dates (Outlook)

• September 18–19: Bank of Japan Monetary Policy Meeting (Statement Expected Around 9/19).

• End of October & Mid-December: Bank of Japan Meetings.

• End of August: Deadline for Outline Requests (Each Ministry).

• December: Target for Government Budget Proposal Decision.

• January–March Next Year: Parliamentary Deliberations and Enactment (Usually).

• Political Situation: If the Liberal Democratic Party decides on an early leadership election, September is a strong window of opportunity.Japan Information OlympicsEquals MoneyThe Japan TimesNipponInvesting.com

8. Checklist for Investors and Practitioners

1. "Frequency" and "Direction" of Political Headlines

2. Achievement of Budget Formulation Milestones (Outline Requests, Internal Notifications, Government Proposal)

3. Data Dependency at Each Bank of Japan Meeting (Wages, Prices, External Shocks)

4. Interest Rate Curve and JGB Supply and Demand (Institutional Investors' Reallocation)

5. Re-examination of Hedge Strategies in Rising Forex Volatility Phases

9. Summary —— The Japanese-Style Risk of "Simultaneous Policy Decisions"

The current uncertainty arises from the overlap of three decision-making processes that usually proceed separately: the legitimacy of the administration, the scale and allocation of the budget, and the timing and pace of interest rates, all on almost the same calendar. The critical point is September. If political decision-making advances here, the volatility of "budget, interest rates, forex, and stocks" may settle down, but if it falters, provisional operations and policy delays become more realistic. Both the market and households will continue to closely