ANALYSIS-Decisive win for Japan PM Takaichi may be best scenario for bonds, yen

By Kevin Buckland

TOKYO, Feb 5 (Reuters) - A landslide win for Japan's ruling Liberal Democratic Party (LDP) at Sunday's election may be the best outcome for bonds and the yen, analysts say, even as Prime Minister Sanae Takaichi's spending pledges have repeatedly rocked markets.

The vote has investors on edge because fiscal worries have sparked a stomach-churning selloff in the currency and bond markets, and a further leg lower would likely reverberate globally.

Last month's shakeup of Japanese debt pushed up borrowing costs from the U.S. to Germany DE10YT=RR, US10YT=RR and provided a stark reminder to markets of the high debt levels and government spending coursing through major economies.

However, analysts say an overwhelming LDP victory may in the end be positive for bonds, as it would eliminate the need for Takaichi to negotiate with opposition parties, who are touting even deeper tax cuts and broader fiscal spending.

And a big buffer would give her a freer hand to respond to pressure from markets, as she has in the past, and adjust policies to head off yen weakness or higher borrowing costs.

The LDP and coalition partner Ishin could together capture as many as 300 seats in the 465-seat lower house, a poll this week showed.

"I don't know if it's going to be a landslide, but certainly Takaichi finds herself in an advantageous situation," said Shoki Omori, chief Japan desk strategist at Mizuho Securities.

"That's why she doesn't necessarily need to worry about further ramping up spending," he said. "Initially, I think the LDP and Takaichi were a little bit desperate, so to speak."

Japanese government bond (JGB) yields have soared to all-time peaks since October, when Takaichi - a fiscal dove and acolyte of former premier Shinzo Abe's "Abenomics" policies - won the LDP leadership. Yields rise when bond prices fall.

The yen, meanwhile, has languished at a near 18-month low against the dollar, prompting Japanese policymakers to repeatedly threaten action - code for intervention in markets - to defend the currency.

COST-OF-LIVING ANGST

The rising cost of living is a core issue at this election, and voter angst has partly been directed at persistent yen weakness for driving up the cost of imports.

Climbing bond yields push up mortgage rates and borrowing costs for businesses, and a debt market rout risks spilling over into Japanese equity markets, like it did last month.

Immediate reactions following Sunday's election result could send the yen and bonds lower, analysts said, but that in turn could prompt a policy response or at least an acknowledgement of market concerns from Takaichi - perhaps as soon as a post-election news conference on Monday.

Earlier this week, Takaichi hastily backtracked on campaign-trail remarks seen as favouring a weak yen. Back in November, she was forced to clarify her fiscal doctrine after the bond market balked at a 21.3 trillion yen ($135.72 billion) stimulus package.

The U.S., which has criticized convulsions in Japanese markets for spilling over to the United States, has also been asking Tokyo to calm the market - something which may be easier with a large parliamentary majority.

"Although the administration may initially aim to strengthen its proactive fiscal expansion, pressure from the markets and the U.S. administration would compel it to exercise restraint," Barclays analysts led by Shinichiro Kadota, head of Japan FX and rates strategy, wrote in a client note.

"The reduced need for cooperation with the opposition would also support this shift."

So-called super-long bonds have been particularly sensitive to perceived loosening of fiscal restraint in Japan, the developed world's most indebted nation.

Yields on 30-year bonds JP30YTN=JBTC surged to a record 3.88% on January 20 after Takaichi called Sunday's election and pledged a two-year hiatus on food tax without specifying how she would fill the estimated 10 trillion yen revenue hole.

To be sure, that selloff could very well find further traction, said David Roberts, head of fixed income at Nedgroup Investments in London, and investors around the world are watching.

ADVANTAGE TAKAICHI?

But Takaichi's pledge to suspend the 8% food tax for two years already looks conservative against the main opposition Centrist Reform Alliance's call to abolish it outright, and the up-and-coming Democratic Party for the People's desire to slash the entire spectrum of value-added taxes to 5%.

Market speculation has even started to emerge that Takaichi could ultimately avoid waiving the food tax altogether, as she finds herself on much more solid footing than 2-1/2 weeks ago, when she made the pledge.

"What the LDP has promised is to 'work on' a reduction of the consumption tax on foods," rather than a firm commitment to implement a cut, said Norihiro Yamaguchi, senior Japan economist at Oxford Economics.

"But if there is no longer a need to accommodate the opposition's demands, the necessity for doing so naturally diminishes."

($1 = 156.94 yen)