(Bloomberg) — Japan faces a period of political instability after the ruling coalition failed to secure a majority in parliament for the first time since 2009, sparking a race between two main blocs to form a government .

Prime Minister Shigeru Ishiba’s gamble to call early elections backfired as voters punished his ruling Liberal Democratic Party after revelations last year that party members systematically failed to declare donations of their supporters.

A count by public broadcaster NHK shows that the LDP and Komeito have a total of 215 seats, fewer than the 233 needed for a majority in the lower house, with more than half a dozen other parties sharing the 250. others. Japan received 148 seats, the channel said.

The yen fell to a three-month low, weakening about 1% against the dollar, while Japanese stocks rose on the prospect that any coalition government would need a broad spending plan to support the economy. The results also raise questions about the future of Ishiba, who took power on October 1 after narrowly winning a vote for LDP leadership.

“We have not been able to dispel public anger over the issue of political funds,” Ishiba said on Sunday before the latest results. Asked if he would consider forming a coalition with other parties, he said no decisions had been made, but added that he was willing to cooperate with others if the policies lined up.

A special session of Parliament must be held within 30 days of a general election to choose a prime minister, according to Japan’s constitution. If no one obtains a majority, a runoff is held between the top two candidates, with the winner taking the top job. The upper house of Parliament, currently controlled by the LDP-led coalition, chooses a prime minister separately, but the lower house’s decision takes precedence if the two bodies choose different people.

Either way, Japan appears to be facing a weak government, an outcome that could complicate the Bank of Japan’s outlook. The central bank, which is trying to find the right time for another rate hike, is expected to leave rates unchanged at its next meeting scheduled for October 31.

“The LDP suffered a crushing defeat,” said Takeshi Minami, chief economist at the Norinchukin Research Institute, who sees a December rate hike as the main scenario.

“There is still time until December, but the difficulty is that the BoJ has said it will not raise interest rates while the markets are in turmoil,” he added. “The impact of the US presidential election also remains to be measured, which means that uncertainty in the markets is increasing.”

The LDP faces a similar situation to the 1993 lower house elections, where it lost its majority but remained the largest party in Parliament. After weeks of negotiations, seven opposition parties formed a coalition and ousted the LDP from power for the first time since 1955. The coalition collapsed in less than a year and the LDP returned to government.

So far, no other party has indicated that it would be willing to join the coalition and help the PLD stay in power. Leaders of small opposition parties said they did not intend to negotiate with the ruling coalition, but could cooperate on specific policy issues.

“This could create a quagmire regarding the legislative process – a scenario that does not bode well for the yen and the Nikkei, at least in the short term,” said Tim Waterer, chief market analyst at KCM Trade, based in Sydney.

The biggest winner of the election was the CDP, which significantly increased its number of seats from 98 before the vote. CDP leader Yoshihiko Noda said he would seek to take power if the coalition lost its majority.

“If we are in an environment where we can strive for this, of course we should go for Japan’s leadership,” Noda said. “I have said that a change of government is the greatest political reform and I want to pursue it.”

Ishiba took over as party leader last month as the LDP sought a definitive break from the scandal that eroded former Prime Minister Fumio Kishida’s popularity.

He banned some lawmakers implicated in the scandal from running as LDP candidates in elections, aiming to assert his authority and regain public trust. That left 10 of them running as independents, with two others expelled from the party also running. Ishiba also stumbled after ascending to the premiership, flip-flopping several times on his policy positions, including his views on the BoJ’s rate normalization path.

“If we lose the majority, we will seek cooperation from as many people as possible,” LDP elections chief Shinjiro Koizumi said after NHK’s exit polls on Sunday. “The PLD must change more radically, reflecting on this harsh judgment. »

Koizumi resigned from his post on Monday, saying he wanted to take responsibility for the election results.

Ishiba’s challenge will likely be made more difficult by the demands that potential partners might present as the price of cooperation. For example, the conservative People’s Democrats is ideologically close to the LDP but wants to cut the sales tax in half and increase income tax deductions.

“If the PLD needs other parties, what can Ishiba give them? said Rintaro Nishimura, a Japanese partner at The Asia Group, a consultancy. “Other parties may think there is no merit in helping a sinking ship.”

Even if Ishiba gains enough support to remain prime minister, the expected outcome will complicate his ability to pursue policy goals such as increasing funding for regional growth and raising taxes to finance increased defense spending. A lost majority in the coalition could push him to adopt more populist measures, such as additional social spending or even tax cuts.

“There are strong calls within opposition parties for expansionary fiscal policies as well as reductions in consumption taxes, so I think the LDP could be pushed in that direction,” said Yuichi Kodama, an economist at the Meiji Yasuda Research Institute. “If the supplementary budget provides generous subsidies for price-cutting measures, there is a good chance that it will be oversized and that long-term issues like fiscal consolidation will be delayed.”

–With help from Umesh Desai, Takashi Hirokawa, Go Onomitsu and Yuko Takeo.

(Updates with developments in the yen, Koizumi’s resignation as election chief)

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