In a general election held over the weekend, a coalition led by the ruling Liberal Democratic Party of Japan lost its legislative majority, raising political instability for the country in the months ahead.

Now, attention was on Prime Minister Shigeru Ishiba and the LDP's attempts to hold onto power, which are probably going to entail forming alliances with local parties.

However, following the results, Japanese markets rebounded, with the Nikkei 225 and TOPIX both gaining about 2% due to wagers that heightened political unpredictability would encourage greater fiscal expenditure while also restricting the Bank of Japan's ability to raise interest rates further.

This idea was supported by analysts, who predicted that a shattered political landscape would allow the Japanese government to increase fiscal spending, particularly if the LDP makes a push to stay in office.  

The unstable political climate, according to Citi analysts, made "large-scale economic stimulus" more likely, which is good news for Japanese markets.

Citi said that although there was some uncertainty for Japanese markets due to the possibility of higher government turnover, any unfavourable response was probably going to be constrained by the country's economic growth, which is characterised by a "virtuous cycle" of increasing inflation and better earnings.

Additionally, according to UBS analysts, a lower LDP meant greater fiscal expenditure and more assistance for small enterprises and people. For equities investors, such a scenario offered a positive outlook, but UBS cautioned that political unpredictability and a possible downgrading to Japan's credit rating due to a larger budget deficit may still encourage selling.

When the BOJ meets later this week, UBS anticipates that it will maintain expectations of more rate rises while keeping interest rates steady.

(Sources: investing.com, reuters.com)