ANALYSIS: Japanese Prime Minister faces market pressure amid falling support

TOKYO — Japanese Prime Minister Sanae Takaichi is struggling in public opinion polls, making it harder for her government to push ahead with promised tax cuts and weakening its ability to reassure investors concerned about the yen and bond markets.

Takaichi’s approval rating fell in July to its lowest level since she took office last year as rising inflation, partly driven by higher import costs from a weaker yen, weighed on public support.

Her push for fiscal stimulus and criticism of higher interest rates have increased investor concerns over Japan’s public finances, sending government bond yields higher.

The market concerns have also limited government efforts to curb speculative bets against the yen, according to government sources.

“Markets are gaining control over fiscal management, which hasn’t happened in Japan for decades,” one source said, warning of the risks posed by bond investors demanding higher returns.

Takaichi has tried to balance a pro-growth economic agenda with efforts to maintain investor confidence in fiscal discipline and the independence of the central bank. However, the conflicting goals have created challenges for her administration’s communication strategy and contributed to market volatility.

Her spending plans, aimed partly at easing household costs, pushed bond yields to three-decade highs in July as investors worried about Japan’s rising debt burden.

Takaichi said on Monday that her administration would work to strengthen market trust through clearer communication about Japan’s finances.

“I would say communication with markets would become more important,” she said when asked about areas where her government could improve.

Despite the decline in approval ratings, Takaichi reaffirmed her commitment to ending what she called Japan’s “excessive fiscal tightening” through increased investment, signaling that she would not abandon her expansionary policies.

“The sliding approval ratings would only solidify the premier’s determination to cut tax and boost investment,” another source said, adding that changing course could hurt her popularity while continuing the policies could unsettle markets.

The challenges could intensify as the government prepares for decisions that may trigger further increases in bond yields.

Takaichi is expected to move forward with a plan to temporarily reduce an 8% tax on food by two years, according to domestic media reports. Analysts warned that unclear funding plans could add pressure to bond markets.

The government also plans to remove spending limits for key growth sectors during its budget review process, a move that could increase expenditure and debt issuance next fiscal year.

“Takaichi tried to explain how her administration was mindful of the need for fiscal discipline. But her policies themselves won’t change much, so there’s not much hope in bond markets that things could change,” said Atsushi Takeda, chief economist at Itochu Research Institute.

While rising bond yields remain a concern, Takaichi’s fiscal and monetary approach has also created challenges in currency markets, with the yen falling to a four-decade low.

Finance Minister Satsuki Katayama’s warnings of possible “decisive” action have kept markets cautious but have failed to provide lasting support for the currency.

Japan’s top currency diplomat Atsushi Mimura has remained quiet since a $72 billion intervention between late April and early May failed to reverse the yen’s decline.

The government has shifted its focus from verbal warnings about the yen to providing clearer details on its debt and fiscal plans.

Katayama said the government would not set a limit on annual debt issuance but would keep borrowing levels within a range considered acceptable by investors.

Takashi Fujiwara, chief fund manager at Resona Asset Management’s fixed income investment division, said Katayama’s communication style has helped support the Japanese government bond market.

“The government’s communication on JGBs is increasing because every time the government announces something new, there is a ‘shock’ in the market, and that subsequently weakens the yen,” Fujiwara said.

Takaichi and Katayama are now presenting their expansionary fiscal policies as measures to improve Japan’s growth potential and strengthen confidence in the yen and government bonds.

However, investors remain cautious, with bond yields expected to rise further as concerns grow over increased debt issuance and Japan’s worsening fiscal outlook.

The yen could face additional volatility this week as the U.S. Federal Reserve and the Bank of Japan hold policy meetings. While both central banks are expected to keep interest rates unchanged, a more hawkish signal from the Fed could accelerate the yen’s decline against the dollar.

“The administration faces two big headwinds: slumping approval ratings, and declines in the yen and JGBs caused by eroding market trust in its fiscal policy,” said former Bank of Japan board member Takahide Kiuchi.

“To recover market trust, the administration needs to show with specific facts and figures its focus on fiscal discipline.”

-Reporting by Leika Kihara and Tamiyuki Kihara; additional reporting by Makiko Yamazaki and Junko Fujita; Editing by Sam Holmes/Reuters