TOKYO (Kyodo) -- Tokyo stocks are likely to test new highs in 2025 backed by hopes for an economic recovery with wage growth, but uncertainties loom over Japan's political landscape and the policies of incoming U.S. President Donald Trump.

The benchmark Nikkei Stock Average could advance toward 45,000, experts said, surpassing the all-time high of 42,224.02 reached in July after exceeding in February the previous record set during Japan's asset bubble era in 1989. The index ended 2024 with an annual gain of 19 percent at 39,894.54.

The weakness of the yen was a major contributor to the stock market's strength in 2024, boosting the overseas earnings of exporters when repatriated. But the Japanese currency is likely to firm moderately, trading in a range from 140 to 160 against the U.S. dollar after hitting a 37-year low in the upper 161 level in July, analysts said.

The movements of the yen, which was trading in the upper 157 range to the dollar in late December, are likely to reflect the stances of the U.S. and Japanese central banks, with expectations that the Federal Reserve will remain cautious about further easing monetary policy while the Bank of Japan raises interest rates at a slow pace.

While the dollar-yen rate is likely to have a limited impact on equities next year, an economic recovery at home is expected to make stocks attractive for investors, with Japan appearing finally to be on a path to realizing wage growth that outpaces inflation, analysts said.

Japanese firms offered historic increases at this year's annual pay talks, helping wages to outpace inflation in June for the first time in over two years. Wages also rose in July but turned negative in the following three months.

Real wages could stabilize in positive territory in 2025 as firms are expected to continue raising pay amid persistent labor shortages, according to economists.

The Japanese Trade Union Confederation, also known as Rengo, has said it intends to again seek raises of 5 percent or more at pay negotiations in the spring, while the government is urging companies to sharply increase wages.

"The strong momentum we saw in the market until around July seems to have settled for now, but that doesn't mean interest in Japanese stocks has completely disappeared. I believe there is still lingering optimism," said Masahiro Yamaguchi, head of investment research at SMBC Trust Bank.

Stocks are also likely to be boosted by the Tokyo bourse's ongoing reforms encouraging listed companies to enhance shareholder value, including by increasing dividends.

"Companies that have not met listing criteria will face the end of their grace period next year, which could lead to delisting. This might push companies to consider mergers and acquisitions, sell-offs, or even going private through management buyouts," Yamaguchi said. "All of these scenarios could contribute to higher stock prices."

But whether Tokyo stocks can reach new highs will hinge on the extent to which the next U.S. president's policies, in particular tariffs, affect Japanese companies, analysts say.

"Even if tariffs are not directly imposed on Japan, those on countries like Mexico could negatively impact the performance of automotive and other exporter stocks," said Makoto Sengoku, senior equity market analyst at Tokai Tokyo Intelligence Laboratory Co.

While Japan could benefit from a trade war between the United States and China by gaining its Asian neighbor's market share, a slowdown in the world's second-largest economy would also adversely affect domestic firms, analysts said.

Political uncertainty at home also poses a risk to the market after Prime Minister Shigeru Ishiba's ruling coalition failed to retain its majority in the House of Representatives in the general election in October, analysts said.

Attention is now focused on whether the ruling camp of the Liberal Democratic Party and the Komeito party will maintain control of the House of Councillors in the election expected in July.

"Having an environment conducive to policy debate and progress could be considered more favorable from a domestic viewpoint, but stability in government is more appealing from an external perspective, with a majority controlled by the ruling party being preferable," said Sengoku.

In the currency market, the yen is expected to appreciate against the dollar, but the pace is likely to be moderate as the interest rate differential between Japan and the United States is projected to remain wide, dealers said.

While further interest rate hikes by the BOJ are on the table in 2025, any firming of the yen is unlikely to be sustained "given the pace will likely be one hike every six months and the policy rate won't exceed 1 percent," said Yamaguchi.

The Fed has also shifted to a cautious stance regarding rate cuts as Trump's proposals on tariffs, tax cuts and stricter immigration policy have raised the prospects of higher inflation after he takes office on Jan. 20, about a week before its next policy meeting.

Yukio Ishizuki, senior foreign exchange strategist at Daiwa Securities Co., said the yen may gradually appreciate to the 140 range against the dollar by the end of next year as the market has likely overreacted to the possible impact of Trump's policies.

"There was a perception that Trump's policies could fuel inflation, which has led to (long-term) interest rates rising too much. I expect some corrections next year," said Ishizuki.

(By Donican Lam)