Japan's inflation-hit voters punish the LDP ahead of Ishiba's trade deal

Japan's inflation-battered voters delivered a historic result in the July 20 election, blocking the Liberal Democratic Party from a majority coalition in both houses of parliament for the first time since the 1950s.

The vote also set the stage for the trade deal Prime Minister Shigeru Ishiba struck with Donald Trump less than a week later. Reports in the Japanese press (denied by the PM) have said Ishiba might resign soon; after resisting demands for tariffs on automakers, he agreed to a 15% across-the-board levy on exports to the US. "Mission completed," Ishiba's trade envoy posted on X.

Our first chart visualizes how the rising cost of living has galvanized voter discontent. Inflation has remained above the Bank of Japan’s 2% target for more than three years. Core inflation eased substantially in 2024, but returned this year. Food prices have been a key driver, with rice prices in particular having doubled — contributing to household strain and broader social unrest. The SRI-Hitotsubashi Consumer Purchase Price Index, an alternative real-time inflation tracker, also points to a continued uptrend in consumer prices.

 Our second chart shows how wage gains are being more than offset by inflation. In May, real wages fell at the fastest pace in nearly two years.

 Our third chart examines pay increases reported by the Rengo labor organization. While unionized Japanese workers received their biggest average pay hike in 34 years (5.26%), wage increases at small and medium-sized enterprises (firms with fewer than 300 staff, which account for roughly 70% of employees in Japan) fell well short of expectations.

Upcoming summer wage data will be critical in gauging the impact of Shuntō wage negotiations on real incomes -- and will also inform the BoJ’s path toward policy normalization. The central bank is expected to leave its key rate unchanged at its July 30-31 meeting.

These economic challenges (coupled with political scandals within the LDP) have pushed voters toward opposition parties advocating more expansionary fiscal stimulus, such as a cut to consumption taxes. However, as Japan carries the highest debt burden in the world, any move toward large-scale stimulus could raise concerns about fiscal sustainability.

 As our fourth chart shows, these concerns have partly led to a recent steepening in Japan’s yield curve, with long-dated JGB yields rising. (We've added a measure of perceived uncertainty to the chart through an index that tracks keywords in news coverage.)

Another noteworthy result of the election was the rise of Sanseitō, a right-wing populist party with a strong anti-immigration stance that gained notable support among younger voters. The party’s ascent reflects growing public unease over Japan’s demographic shifts and stresses from the recent tourism boom.

As the birthrate declines and the population has aged, Japan’s reliance on foreign labor has steadily increased. As our final chart shows, the number of foreign workers has quadrupled from about 500,000 workers in 2008 to over 2 million in 2024.

The outlook for Japanese markets is unclear in the aftermath of the election and trade deal. The tariffs will weigh on Japanese industry over the longer term, and there will be more competition from US auto imports in the domestic market. However, the levies were lower than Trump's initial demands. Greater market access for US agriculture might also restrain food inflation. The perceived certainty from the deal has sent automakers' shares rising -- and reduces economic risks as the Bank of Japan weighs whether to keep raising rates in line with inflation.

Click here for our dashboard covering inflation dynamics across other major economies.