Japan Bond Yields Hit 25-Year High as BOJ Warns on Volatility and PM Takaichi Calls Snap Election

Bond market jolted by rapid rise in yields

TOKYO — Japan’s benchmark government bond yield has climbed to its highest level in more than a quarter century, testing the limits of the country’s debt-heavy economic model just as its central bank and new prime minister pull policy in sharply different directions.

At the end of a two-day meeting that concluded Friday, the Bank of Japan left its short-term policy rate unchanged at 0.75%, the highest since 1995, but Governor Kazuo Ueda warned that long-term interest rates were rising at what he called a “significantly rapid” pace. He said the central bank stood ready to adjust its bond purchases “flexibly” if moves in the market became disorderly.

The message came as investors digested a separate shock from the political arena. Prime Minister Sanae Takaichi, who took office in October as Japan’s first female leader, has dissolved the lower house of parliament and called a snap general election for Feb. 8, seeking a mandate for a campaign centered on tax cuts and higher public spending.

The combination has jolted Japan’s once-placid bond market. The yield on the 10-year Japanese government bond (JGB) touched about 2.26% this week, with some trading data showing intraday peaks closer to 2.4%, levels not seen since 1999. Yields on 40-year bonds briefly rose above 4.2%, the highest since that maturity was introduced in 2007.

For an economy whose gross public debt is more than 230% of gross domestic product — the highest ratio among advanced nations — even modest increases in borrowing costs matter.

“We are seeing long-term interest rates rise at a significantly rapid speed,” Ueda said at his news conference in Tokyo. “If such moves deviate from economic fundamentals or become excessive, the Bank will respond flexibly through its market operations.”

BOJ holds rates as internal split grows

The central bank’s policy board voted 8–1 to keep the short-term rate near 0.75%. The lone dissenter, board member Hajime Takata, argued for an immediate rate increase, according to the decision summary, underscoring a growing split inside the institution over how quickly to move away from the ultra-easy stance that has defined Japanese monetary policy for years.

In its quarterly outlook, the Bank of Japan nudged up its growth forecasts, projecting the economy will expand about 0.9% in fiscal 2025 and 1.0% in 2026. It expects core consumer inflation — which excludes fresh food prices — to run at around 2.7% in fiscal 2025 before easing to just under its 2% target in 2026.

Those projections, along with a board member openly favoring a hike, led many analysts to see the decision as a pause rather than an end to rate increases. Market pricing after the meeting suggested investors expect the policy rate to reach around 1% later this year if wages and prices continue to rise steadily.

The central bank has spent the past two years engineering a slow exit from its experiment with negative interest rates and yield-curve control, which for years capped long-term bond yields near zero. It ended negative rates in March 2024 and has since lifted its key rate in stages, while outlining a plan to gradually shrink its massive JGB purchases.

At the same time, Ueda has repeatedly emphasized an escape clause: if long-term yields spike too quickly, the bank is prepared to step in with larger bond purchases or fixed-rate buying operations to stabilize the market. His latest comments were the clearest signal yet that officials are watching the recent sell-off in government bonds with concern.

Snap election puts fiscal policy at center of campaign

The political backdrop is complicating that task.

On Monday, Takaichi announced she would dissolve the House of Representatives and call an election for early February, well ahead of the current term’s expiration. The move is widely seen as an attempt to capitalize on relatively strong approval ratings before higher interest rates or external shocks weigh on the economy.

Central to her campaign is a promise to suspend for two years the 8% reduced consumption tax rate on food, effectively cutting the levy on most groceries to zero. Government and independent estimates have put the revenue loss at around ¥5 trillion a year, or the equivalent of more than $30 billion, though the precise cost will depend on details that have yet to be finalized.

“We must ease the burden on households facing higher prices for daily necessities,” Takaichi said in a speech outlining the plan.

She has described the step as part of a broader “crisis management” strategy that also includes increased spending on defense, semiconductors and other strategic sectors.

Opposition parties have countered with their own versions of food-tax relief, with some proposing longer or broader cuts. That has turned fiscal loosening into one of the few areas of consensus in the campaign, even as Japan’s overall debt pile continues to rise.

Debt burden and BOJ balance sheet amplify the stakes

Investors are now weighing that fiscal trajectory against the central bank’s desire to keep inflation under control as it normalizes policy.

Japan’s government debt totaled more than ¥1,320 trillion at the end of the last fiscal year, according to Finance Ministry data. About 88% of that is held domestically, and the Bank of Japan itself owns close to half of all outstanding JGBs following years of large-scale purchases.

Those holdings give the central bank powerful tools to influence the market, but they also mean its decisions can have outsized effects on prices. By tapering its bond buying, the BOJ has allowed yields to rise. Yet if it now responds to volatility by ramping up purchases again, it risks blurring the line between temporary market support and a renewed commitment to quantitative easing.

Financial institutions are feeling both sides of the shift. A steeper yield curve — with short-term rates still low and longer-term yields rising — generally improves net interest margins for banks and life insurers. But the rapid adjustment is inflicting mark-to-market losses on portfolios heavily invested in long-duration JGBs.

For households, the impact is mixed. Many mortgages and small-business loans in Japan are tied to variable interest rates, so borrowing costs are expected to drift higher as policy tightens. At the same time, savers who have endured years of near-zero returns on deposits and government bonds are beginning to see slightly higher yields.

The immediate relief from a food tax cut, if enacted, would fall most heavily on lower- and middle-income families, who spend a larger share of their income on groceries. Economists say that would provide some support for consumption, which has been uneven despite solid corporate profits and a gradual pickup in wages.

Global ripple effects from higher Japanese yields

Beyond Japan, the move in JGBs is reverberating through global debt markets. Investors and strategists say the rise in Japanese yields is one factor pushing U.S. 10-year Treasury yields toward about 4.3% and German 10-year bund yields close to 2.9% in recent sessions, as higher domestic returns make Japanese bonds more attractive relative to foreign assets.

Japanese banks, insurers and pension funds are among the largest overseas holders of U.S. and European government debt. If they continue to find better returns at home, that could reduce demand for foreign bonds and keep upward pressure on global borrowing costs.

For now, the central bank is signaling patience. Ueda said Friday that officials would watch the impact of the December rate hike and subsequent market moves “carefully” before deciding on the timing of any further adjustments. He reiterated that achieving a “virtuous cycle” of rising wages and prices remains the bank’s main objective.

How that cautious approach meshes with an election campaign built around tax cuts and new spending will be tested in the coming weeks. The vote on Feb. 8 will determine whether Takaichi secures the political backing to push ahead with her agenda, even as higher interest rates and a restless bond market begin to impose new constraints on the world’s most indebted major economy.