Policy expectations and market enthusiasm intertwine, Japanese bank stocks stand at the forefront

The policy stance of Japan's new leader, Sanae Takaichi, is reshaping investors' expectations for the banking sector.

Although market expectations for loose monetary policy have put pressure on bank stocks, analysts believe that the demand for project financing driven by expansionary fiscal policy and the rapid depreciation of the yen may force the central bank to raise interest rates, which is expected to sustain the bull market for bank stocks.

In this week's "Takaichi Trade," which propelled Japanese stocks to record highs, the banking sector initially underperformed. On Monday, while the Nikkei index soared by 4.75%, the Tokyo Stock Exchange Bank Index fell by 0.12%, as investors worried that the loose monetary policy supported by Takaichi might delay the central bank's interest rate hike plans.

The initial focus of the market was on Takaichi's supportive stance on fiscal stimulus and loose monetary policy. While this provides strong support for the stock market, it may also delay the Bank of Japan's interest rate hike plans, thereby weakening future profit sources for banks, which is a core reason for the pressure on bank stocks.

However, since the Bank of Japan ended its ultra-loose policy in March last year, bank stocks have risen by 47%, far exceeding the Nikkei index's 21% increase during the same period. Goldman Sachs Japan financial analyst Makoto Kuroda noted that both regional banks and large banks will benefit from the broad expansionary policies based on economic security.

Expansionary Policies Drive Financing Demand

Takaichi has stated that she will prioritize the revitalization of the Japanese regional economy, which may stimulate demand for local banks' expertise. Kuroda pointed out that both regional banks and large banks will benefit from the broad expansionary policies based on economic security.

After years of negative interest rate policies, Japanese banks have developed business models that are less reliant on domestic lending spreads. Japan's largest bank, Mitsubishi UFJ Financial Group, estimates that interest rate hikes starting in January 2025 will increase pre-tax profits by an average of 166 billion yen per year over three years, but this is still less than one-tenth of its record annual profit of 1.86 trillion yen in the previous fiscal year.

"The impact of previous interest rate hikes has not yet fully reflected in earnings, and there is still room for upward adjustments in long-term guidance or return on equity targets," Kuroda said.

Central Bank Independence Limits Political Interference

Despite Takaichi's previous opposition to interest rate hikes raising concerns among investors, analysts generally believe that her ability to pressure the Bank of Japan is limited.

This is mainly because Japanese law guarantees the independence of the central bank from government interference. Nicholas Smith, a strategist at CLSA, stated that Ueda has 2.5 years left in his term, supported by law, and Takaichi is unlikely to consider changing this law.

Yen Depreciation May Force Central Bank to Raise Rates

It is noteworthy that the rapid weakening of the yen may force the central bank to take action.

Since this week, the yen has depreciated by about 3.5% against the dollar, falling to over 152 yen. SMBC Nikko analyst Masahiko Sato stated that central bank decisions are heavily influenced by exchange rates, and if it falls to around 160 yen, raising interest rates to prevent currency depreciation will become possible. **

Smith also warned that the Ministry of Finance holds significant power, and only a strong Prime Minister can make it yield. Whether Takashi has such leadership is still unclear, and overestimating the government's ability to significantly increase spending seems to be a mistake.