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Japan yield curve expected to steepen on Takaichi victory

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Tokyo shares likely to rise, yen to fall

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Takaichi's mandate seen influencing BOJ's rate-hike policy

By Rocky Swift

TOKYO, Oct 4 (Reuters) - Japanese shares are expected to

keep setting records even as the nation's currency and bonds

sputter after fiscal dove Sanae Takaichi was elected on Saturday

to lead the ruling party and likely become prime minister.

Takaichi, 64, was considered to have the most expansionist

fiscal and monetary agenda among five candidates in the Liberal

Democratic Party race to replace hawkish Prime Minister Shigeru

Ishiba.

In the lead-up to the LDP race, a "Takaichi trade" emerged -

long on stocks and bearish on Japanese government bonds,

particularly longer maturities - positioning for a win by

Takaichi, a devotee of the "Abenomics" stimulus policies of the

late Shinzo Abe.

'POSITIVE SURPRISE' FOR SHARES, BONDS ON EDGE

Japan's benchmark Nikkei logged a record closing

high of 45,769.50 on Friday, topping the record set the week

before, as investors bet whoever succeeded Ishiba would be more

dovish.

Short positions on the gauge have been building up recently

and may now be unwound, said Resona Holdings strategist Hiroki

Takei.

"This could be considered a positive surprise for stock

prices," Takei said. "If short-covering is triggered, the rally

could gain momentum, potentially pushing the index toward the

47,000 level."

The Japanese government bond market has been on edge since

late May due to waning demand among traditional buyers,

decreased support from the central bank and concerns about

swelling debt.

The sector was dealt another blow in July, when Ishiba's

coalition lost its majority in the upper house of parliament -

having lost its lower house majority last year - as outsider

parties campaigning on tax cuts and increased spending gained

seats.

The 30-year JGB yield surged to a record 3.285% on September

8, the first trading day after Ishiba announced he was stepping

down.

In recent weeks, the Nikkei's momentum slowed and

longer-term JGBs rallied as markets gave the edge in the LDP

race to farm minister Shinjiro Koizumi and Takaichi appeared to

moderate her stance, leaving sales tax cuts out of her platform

and staying mostly mum on the Bank of Japan.

"She seemed to have toned down her rhetoric recently but

ultimately the feeling is still that she will push for looser

fiscal and monetary policy," said James Athey, a fixed income

manager at British investment group Marlborough. "As such, there

is likely to be a negative reaction in long-end JGBs and the

yen."

Japan's currency closed at 147.44 per dollar on

Friday, staging a 1.4% gain on the week that was the sharpest

since mid-May.

After her LDP victory, Takaichi told a press conference the

government and central bank must work closely to ensure Japan's

economy achieves demand-driven inflation backed by rising wages

and corporate profits.

Prices for shorter-dated JGBs, those most sensitive to

central bank rates, have been on a declining trend, pushing

their yields higher as evidence mounted that Japan's economy was

sound enough for the BOJ to resume tightening policy.

BOJ Governor Kazuo Ueda has put the central bank on a

long-term path to raise interest rates and shrink its balance

sheet after more than a decade of massive stimulus that was a

key part of former Prime Minister Abe's economic platform.

Yields on two-, five-, and 10-year JGBs have all reached

levels not seen since the financial crisis in 2008 on bets the

BOJ could raise rates as early as this month's meeting.

Takaichi's wide support among rank-and-file LDP members will

lend her cabinet a strong mandate and a heavy hand in

influencing monetary policy by the BOJ, said Tohru Sasaki, chief

strategist at Fukuoka Financial Group and a former BOJ official.

"Takaichi will make it difficult for the BOJ to raise rates,

so yields will go lower," Sasaki said. "But at the same time,

she's likely to expand spending, which is negative for bonds. A

steepening of the yield curve is a possible reaction."