Market doubts overshadow central bank tightening
Japan could face further weakness in the yen and continued upward pressure on government bond yields as investors grow increasingly uneasy about the country’s expansionary fiscal policy, according to former Bank of Japan policymaker Seiji Adachi.
The yen has continued to slide even after the Bank of Japan raised interest rates last Friday to 0.75%, the highest level in 30 years. Markets interpreted Governor Kazuo Ueda’s comments after the meeting as a signal that additional rate hikes will be gradual rather than aggressive.
Fiscal risk drives investor sentiment
Adachi, who served on the BOJ board until March, argued that currency weakness has little to do with monetary policy. He said the yen is falling despite a narrowing gap between Japanese and U.S. interest rates, suggesting that investors are instead focused on Japan’s fiscal outlook.
According to Adachi, markets are beginning to demand a higher premium for Japan’s fiscal risk. This shift in sentiment is also evident in the rise of Japanese government bond yields, which reflect growing concern over debt sustainability.
Bond yields hit multi decade highs
The benchmark 10 year Japanese government bond yield climbed to 2.1% on Monday, its highest level in 27 years. The move reflects expectations of additional rate increases by the BOJ as well as heavy bond issuance to finance government spending.
Adachi said the central bank could eventually lift interest rates to around 1.5%, with the next hike potentially coming around July next year. However, higher rates would also raise the cost of servicing Japan’s already massive public debt.
Expansionary budgets amplify concerns
The pressure on markets is likely to intensify as Prime Minister Sanae Takaichi advances a pro growth fiscal agenda. Japan’s next fiscal year budget, the first under her leadership, is expected to exceed 122 trillion yen, setting a new record and requiring bond issuance above last year’s 28.6 trillion yen, according to local media.
This would add to a 21.3 trillion yen stimulus package funded through an extra budget for the current fiscal year, aimed at shielding households from rising living costs. Together, these measures are reinforcing investor concerns about the country’s fiscal discipline.
Rising yields pose a key economic risk
Adachi warned that if the bond selloff continues, the BOJ may need to revisit its bond tapering plans or develop measures to support smaller banks facing losses on their bond holdings. He stressed that rising yields could become the most significant threat to Japan’s economy in the coming year.
“It will be difficult to erase market doubts about Japan’s finances,” Adachi said, adding that higher bond yields represent the largest risk to economic stability next year.
