By John Geddie and Tim Kelly
TOKYO (Reuters) -Japan's shaky minority government is poised for another setback in an upper house vote on Sunday, an outcome that could jolt investor confidence in the world's fourth largest economy and complicate tariff talks with the United States.
Prime Minister Shigeru Ishiba's Liberal Democratic Party (LDP), which has ruled for most of the post-war period, and its partner Komeito, are forecast to lose their majority in a repeat of last year's election for the more-powerful
lower house.
The ruling coalition needs to win 50 seats of the 125 up for grabs in order to retain its majority.
While the vote will not directly determine whether Ishiba's government falls, investors are nervous it will leave him beholden to opposition parties advocating fiscal largesse that could exacerbate mass selling of Japan's government bonds.
In a worst case scenario, some analysts say Ishiba may have to resign, unleashing political drama as Tokyo heads for an August 1 deadline to win reprieve from punishing import levies set by its largest trading partner, the United States.
"If he had an overwhelming loss, I think he would have to resign," said David Boling, director for Japan and Asian Trade at political risk consultancy Eurasia Group.
"That then creates a lot of questions about who replaces him and what impact that has on the US-Japan trade negotiations."
Other financial and political analysts, such as Joseph Kraft of Rorschach Advisory in Tokyo, say the LDP is unlikely to opt for a leadership change at a pivotal moment in talks on tariffs hammering key industries such as automakers.
In a sign of that urgency, Ishiba will take a break from campaigning on Friday to hold talks with Washington's chief tariff negotiator and Treasury Secretary Scott Bessent, who is visiting Japan for the World Expo in Osaka.
'BALANCING ACT'
More likely is that Ishiba will seek to either broaden his coalition or strike informal deals with opposition parties to keep his government functioning after the election, Kraft said.
That prospect has made investors nervous.
Inflation has been a killer issue for Ishiba, as it recently has been for incumbents elsewhere. The price of rice, which has doubled since last year, has become a lightning rod for voter discontent.
In response, opposition parties have promised tax cuts and welfare spending to soften the blow, while the LDP, with one eye on a very jittery government bond market, has been calling for fiscal restraint.
Any opposition deals to weaken that restraint will only heighten investor nervousness about Japan's ability to refinance the world's largest debt pile and hamper the Bank of Japan's long-held goal of normalising monetary policy.
But not only parties advocating for more spending have chipped away at LDP support. The far-right Sanseito, espousing anti-foreigner rhetoric once confined to the political fringe, has been the surprise performer of the campaign.
Birthed on YouTube spreading anti-vax conspiracy theories five years ago, the party may win 10 to 15 seats, polls show.
That would herald the arrival of a new force of populist politics that has yet to take root in Japan as it has in the United States and Europe.
One reason the LDP has stayed so long in power, analysts say, is because it has served as a "broad church" for political views. But bringing into the fold the likes of Sanseito may trigger a deeper crisis of faith.
"If the party (LDP) goes too far right, it loses the centrists," said Tsuneo Watanabe, a senior fellow at the Sasakawa Peace Foundation think tank in Tokyo.
"But without the right wing, it has other problems. It's a balancing act and a tough one."
(Reporting by John Geddie and Tim Kelly; Editing by Clarence Fernandez)
