TOKYO Japan's Nikkei average climbed to its highest closing level in nearly eight months on Wednesday, led by exporters as persistent speculation that a likely new government would pressure the central bank to take bolder policy weighed on the yen.
The Nikkei .N225 advanced 0.6 percent to 9,581.46, taking the index back to 'overbought' territory, with the 14-day relative strength index at 70.9. Seventy or above is considered overbought and often indicates a possible near-term pull back.
The index has rallied 10.6 percent over the past month, driven by a weaker yen after Shinzo Abe, the leader of the main opposition party which is expected to win this Sunday's general election, called for the Bank of Japan to adopt aggressive monetary easing, including embarking on "unlimited easing".
The central bank is also expected to expand its asset-buying and lending programme next week.
Exporters have been the main beneficiary of the softer yen, which was quoted at 82.655 yen to the dollar, not too far from a 7-1/2-month low of 82.84 yen touched on November 22.
"Coordinated fiscal and monetary policy in Japan would be, should be and could be enough to give you a cyclical bull phase that can last six to nine months ... We are bullish," a senior trader at a foreign bank said, adding that the key was picking the right stock.
"Could we see profit-taking post election? Yes. But we are not advising people to. December, January tend to be good months for the Nikkei," he said.
Exporters which led the charge higher on Wednesday included TDK Corp (6762.T), Canon Inc (7751.T), Honda Motor Co (7267.T) and Toyota Motor Corp (7203.T), up between 0.9 and 3.5 percent.
The Japanese financial markets shrugged off the news that North Korea had launched a long-range rocket, stepping up the threat the impoverished state poses to the region.
Panasonic Corp (6752.T) surged 7.2 percent after a source said the consumer electronics maker may sell its Sanyo digital camera business to Japanese private equity fund, Advantage Partners, by the end of March.
The broader Topix .TOPX index ended 0.7 percent higher at 791.29 in relatively active trade, with 1.94 billion shares changing hands, up from Tuesday's 1.54 billion and last week's average of 1.91 billion.
Bank of America Merrill Lynch said it expected the Topix to rise to 880 in the next 12 months in its base case scenario, and under a bull case scenario, the index could reach 1,050, 32.7 percent above where it ended on Wednesday.
"We forecast a rise to 1,050, as the emergence of a strong government, expanded public spending, and the establishment of an inflation target changes market expectations and lifts domestic-demand sectors such as finance and construction in addition to the exporters," Merrill Lynch said in a note.
Japan voters poll graphic: link.reuters.com/xyc34t
Japan machinery orders: link.reuters.com/bek95s
Asset performance in 2012: link.reuters.com/muc46s
But some market participants said the market may see correction after the election as hopes for easy monetary policy are already priced in to the current market.
"Investors who wasted no time chasing the market higher as soon as the yen started weakening will likely unwind their positions soon," said Makoto Kikuchi, the chief executive of Myojo Asset Management. "They probably will just 'eat in moderation', instead of trying to 'full their stomachs.'"
Buoyed by the past month's rally, the Nikkei is up 13.3 percent this year, in line with a 13.5 percent gain in the U.S. S&P 500 .INX but trailing a 14.7 percent rise in the pan-European STOXX Europe 600 .
To protect against any downside risk, BNP Paribas proposed investors sell Nikkei calls with March 2013 expiry and buy puts with the same maturity to take advantage of the flat volatility skew.
"Short-term upside could be limited, and some investors may consider taking profit after the snap election on 16 December. Indeed, there is time gap between the potential change in the BOJ's governor and implementation of bold monetary easing, which is an important agenda under Abe's leadership," the brokerage said in a note.
(Additional reporting by Ayai Tomisawa; Editing by Sanjeev Miglani)