Welcome to the Year of the Elections, Bloomberg’s newsletter on the votes that matter to markets, business, and policy amid the most fragmented geo-economic landscape in decades.

Japan’s election on Sunday was nearly as bad as it gets for a ruling party that has governed for all but a handful of years since its founding in 1955.

The Liberal Democratic Party got smacked around by voters, failing to win a majority for the first time since it got trounced in 2009. That’s largely due to the fallout from a slush fund scandal, in which politicians underreported campaign donations and used the money for personal gain, an affront to many voters now dealing with rising prices for the first time in decades.

To form a government, the LDP is now in the unfamiliar position of reaching out to other parties who aren’t rushing to join hands with a party many voters rejected. The only good news for the LDP is that the opposition — while now strengthened — remains divided.

No matter who ends up forming a government, policy won’t change drastically. Japan operates by consensus on a wide range of issues, most crucially its alliance with the US.

The opposition may push for more accountability for US soldiers based in the country, but fundamentally there’s little appetite to jolt the relationship given the increased threat from China and North Korea, which are providing support to Russia’s Vladimir Putin after his invasion of Ukraine.

WATCH: The failure of Japan’s ruling coalition to win a majority in parliament has added to complexities in the country’s relations with China and the US. Source: Bloomberg

Markets will be looking for any sign of changes to the Bank of Japan’s move to raise interest rates and normalize monetary policy. The main opposition party wants the 2% inflation target changed to “above zero,” which could mean tighter policy, though it would likely be tough to get other parties in a coalition to agree with that stance. Prices over the past few years have risen at the fastest clip in decades.

A bigger worry for investors, however, is that Prime Minister Shigeru Ishiba — who took office on Oct. 1 and vowed to stay on after the election drubbing — may not last long. One potential replacement if the LDP forms a government is Sanae Takaichi, who favors monetary easing and narrowly lost to Ishiba last month in a vote to head the party.

Either way Japan is poised for a weak government just as military and trade tensions pick up around the world. And there’s the possibility that Donald Trump could return to the White House, pressuring Japan even more.

For Japanese citizens, it’s more important to vote in politicians they can trust. Whether that will actually happen remains to be seen. — Daniel Ten Kate

Shinjiro Koizumi, chairperson of the LDP’s election strategy committee, at the party's headquarters in Tokyo yesterday.   Photographer: Toru Hanai/Bloomberg

Taro Kimura, Japan economist with Bloomberg Economics, discusses what’s next for the economy.

It looks like Japan is going to get a weak government no matter what. What does the election result mean for the Bank of Japan’s policy?

For this year, the BOJ may feel political pressure to refrain from increasing rates as rising debt-servicing costs won’t provide good optics to voters. The DPP and Ishin — key opposition parties that Ishiba may want to join a coalition government — won’t easily give a nod to another BOJ rate hike given their policy focus is on assisting struggling households and small and medium-sized firms.

That said, it won’t mean lawmakers will push the BOJ to keep stimulus for much longer. Japan’s inflation has exceeded 2% for more than two years and is gaining momentum with stronger wage growth and a weak yen. With public attention focused on the rising cost of living, opposition lawmakers could eventually call for the BOJ to hike rates to combat those price surges when the political situation starts to settle.

How about on the fiscal side?

Ishiba was known as a staunch critic of Abenomics — the reflationary policies of former leader Shinzo Abe — and has an affinity for normalizing fiscal policy and stabilizing the enormity of Japan’s public debt burden. But he will likely cast that aside for now. Ishiba may ramp up fiscal support for households struggling with rising costs of living, given both the DPP and Ishin campaigned on manifestos calling for tax cuts to help households. That will be supportive for growth at least in the short run. But it will also add fuel to inflation and risk adding to Japan’s public debt, which has already been on a very narrow path to stability.

What will be the main challenges for the next administration?

Obviously Ishiba will be walking a tightrope to survive as premier. He will need to secure support by maneuvering a minority government or expanding his coalition. The LDP hasn’t faced such a situation since the early 1990s. A strong public backlash against a recent LDP fundraising scandal — as well as a cost-of-living crunch due to the surge in inflation — has little prospect of dying down in the near term. Sunday’s election surely ushers in a period of unusually historically high political uncertainty.

Hideyuki Sano, senior Asia stock reporter, writes about how the markets are digesting the LDP’s big setback.

Since late 2012, investors have taken political stability in Japan almost for granted, as the ruling LDP and its coalition partner Komeito held a comfortable majority to govern. That assumption is being put to the test after their poor showing in the election.

Many analysts say a political stalemate is likely to discourage investors from buying Japanese assets, putting pressure on the yen and the country’s stock prices.

Investors expect Ishiba to eventually clinch a coalition deal with a smaller party — most likely the conservative Democratic Party for the People led by former Finance Ministry bureaucrat Yuichiro Tamaki — as it has done in the past when it lost a majority on its own.

Yet since Ishiba’s leadership is likely crippled after the election, markets will remain nervous about how effective he will be in taking steps to make sure the country’s economy will move onto a solid growth path.

The yen is on a slippery slope in particular. His potential coalition partners, the DPFP and Japan Innovation Party, favor a dovish monetary policy, suggesting the Bank of Japan could face more political pressure to raise interest rates. Some market players also think the yen may be weighed down by worries that Ishiba may end up stepping up fiscal spending to court voters in the upcoming Upper House election next year, undermining Japan’s already tattered public finances even further.

Nicholas Takahashi, a Bloomberg reporter in Tokyo, sees shifting prospects for corporate Japan.

For years, the LDP-led government has urged Japan’s biggest companies to unwind their vast web of cross-held shares in a broad push to improve governance and nurture competition. Earlier this year, Toyota Motor Corp.’s plan to buy back 1.2 trillion yen ($7.8 billion) in strategic shares proved the movement was beginning to gain real traction.

A separate effort to attract foreign investment is being tested at the moment by Alimentation Couch-Tard Inc.’s attempted buyout of Seven & i Holdings Co. The Japanese convenience store operator’s rush to hide behind government protection suggests this plan isn’t going as smoothly.

Meanwhile, a plethora of regulatory scandals have cast a shadow on Japan’s car industry, and the Bank of Japan’s moves to end three decades of ultra-loose monetary policy are squeezing thousands of firms flirting with bankruptcy.

Add to that a severely weakened ruling party — a central player in every corporate shift going on right now — and navigating this becomes an even more difficult for Japan’s corporate giants.

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