Japanese stocks may extend gains even as the yen strengthens.

Japanese stocks are likely to continue rising under new Prime Minister Sanae Takaichi even if the yen strengthens, as market momentum is now driven by the strength of broader sectors rather than just the weaker currency.

Takaichi's surprise victory in the Liberal Democratic Party leadership election sent the yen lower and the Nikkei higher as investors bet on the continuity of Abenomics' pro-growth policies of loose monetary policy, fiscal support, and structural reform.

Takaichi is widely seen as a stock market supporter and champion of the policies of late Japanese Prime Minister Shinzo Abe, the analyst said.

The three arrows of Abenomics are flexible monetary policy, fiscal stimulus, and structural reform.

But Capital Economics analysts say the Japanese market has already shown its ability to outperform without further yen decline.

Since early April, when US tariffs on imports were suspended, the yen has remained broadly stable against the dollar, yet Japan still outperforms all other major countries in the MSCI World Index in terms of local currency.

This performance was supported by the technology, telecommunications, industrials, and financial sectors. Industrials benefited from a still-competitive currency, improved domestic growth, and a trade agreement with the United States, while the financial sector benefited from rising Japanese government bond yields as the Bank of Japan slowly tightened policy.

Capital Economics expects the Bank of Japan to raise interest rates more than markets expect over the next two years, which could strengthen the yen.

Although this should not deter stocks from rising, as large tech companies, industrial exporters, and the financial sector are likely to remain resilient, the central bank's gradual withdrawal from stock purchases is unlikely to significantly impact sentiment.

The outlook remains bright for industries as the economy recovers, and for the financial sector as the Bank of Japan's hawkish policy puts further upward pressure on Japanese government bond yields, the note said.