Naoto Kan, the front-runner to become Japan's prime minister, has begun leading a drive to contain the world's largest public debt just months after warning it would be a "challenge" to maintain fiscal discipline this year.

Kan's change reflects his deepening anxiety over the budget deficit after participating in meetings of Group of 20 and G-7 that were dominated by Europe's debt crisis, a Finance Ministry official said on condition of anonymity. Kan, 63, surprised ministry officials and Prime Minister Yukio Hatoyama last month by extending a pledge to cap bond sales through next year.

The impact of Kan's shift on policymaking may be magnified should he succeed Hatoyama, who announced his resignation yesterday after deepening tensions over the U.S. military's presence in Okinawa. Kan would seek to distinguish himself from the previous four leaders since 2006 by pushing for more fiscal discipline and a higher sales tax, according to Barclays Capital.

"People used to think Kan was very much inclined to economic stimulus measures when he became the finance minister," said Kazuhiko Sano, chief strategist in Tokyo at Citigroup Global Markets Japan Inc., who predicts Kan will be selected as prime minister. "He's been changing his tone and stance toward fiscal discipline" after sovereign-debt risks climbed, he said.

Eoin Treacy's view

My view - From a political standpoint, Japan has appeared rudderless since Koizumi left office in 2006 which has been a factor in the underperformance of the Japanese stock market relative to global peers. The strength of the Yen over the same period has also been a headwind for the large export sector and there has been a distinct inverse correlation between the Nikkei and the Yen spot rate since at least 2004.

The US Dollar remains broadly rangebound with a mild upward bias against the Yen and is currently rallying towards the upper side. It pushed back above the 200-day MA this week and a sustained move below ¥89 would be required to question scope for further higher to lateral ranging.

The Korean Won found support near ¥7 on May 25th and continues to rally from that area. A sustained move below ¥7.30 would be required to question scope for some additional higher to lateral ranging.

The Yen Trade Weighted Index encountered resistance in the region of the 2009 high last week and a sustained move to new recovery highs would be required to question potential for a further test of underlying trading.

The Nikkei-225 pulled back violently from its April peak and was short-term overextended when it formed an upside key day reversal last week. It further improved on that performance today and a sustained move below 9400 would be required to question scope for some further higher to lateral ranging.

The Topix Banks Index also found at least short-term support last week in the region of the 2009 and 2003 lows. A sustained move back below 125 would be required to question potential for some further higher to lateral ranging.

The Topix 2nd Section found support in the region of the 200-day moving average last week and a sustained move below 2100 would be required to question scope for some additional higher to lateral ranging.