Japan Bond Yields Surge as Snap Election Pits BOJ Tightening Against New Tax-Cut Pledge

TOKYO — On the same January morning that Bank of Japan Gov. Kazuo Ueda warned that long-term interest rates were climbing at a “significantly rapid” pace, television screens across Tokyo cut to another live broadcast: Prime Minister Sanae Takaichi dissolving parliament, calling a snap general election and promising to scrap the consumption tax on food for two years.

Within hours, the world’s most indebted major economy had laid out a starkly contrasting policy mix — a central bank edging away from decades of ultra-easy money and a new leader campaigning on fresh, debt-financed tax relief — just as investors push Japanese government bond yields to their highest levels since the late 1990s.

BOJ holds at 0.75% and flags bond-market strain

The Bank of Japan on Jan. 23 left its short-term policy rate unchanged at about 0.75%, a roughly 30-year high, after a two-day meeting in Tokyo. The decision, widely expected by economists, came by an 8-1 vote, with Policy Board member Hajime Takata arguing for an immediate rate increase.

At the same time, the bank signaled growing unease over the speed of the sell-off in the ¥1,300 trillion government bond market. Ueda told reporters that Japan’s long-term rates, led by the 10-year government bond, had been rising at a “significantly rapid” pace and that the central bank would conduct its market operations “flexibly” to contain any disorderly moves.

“In the event of a rapid rise in long-term interest rates that is different from normal market movements, the Bank will make nimble responses, such as increasing the amount of JGB purchases,” Ueda said, referring to Japanese government bonds.

The warning underscored a dramatic shift in a market that for years was defined by near-zero yields and heavy central bank intervention. The benchmark 10-year JGB yield has climbed to around 2.26%, its highest level since 1999, after touching intraday peaks near 2.4% in the days around the meeting. At the ultra-long end, the 40-year yield briefly rose above 4.2%, the highest since that bond was introduced in 2007.

Those levels remain low by U.S. or European standards. But they represent a sharp adjustment for a country carrying gross government debt estimated at about 230% to 235% of gross domestic product — the largest ratio among advanced economies — and for investors accustomed to years of effective yield-curve control by the BOJ.

Japan has relied heavily on ultra-low rates to finance its obligations. The central bank itself now holds nearly half of outstanding JGBs after a decade of massive purchases. A sustained rise in yields increases the government’s future interest bill as it refinances debt and could expose banks, insurers and pension funds to valuation losses on their large bond portfolios.

A cautious exit from ultra-easy policy

The backdrop to the BOJ’s caution is a fragile exit from the extraordinary policies put in place to fight deflation. In March 2024 the bank scrapped its negative interest rate policy, raising rates for the first time in 17 years. It has since lifted the policy rate in stages to 0.75%, including a December 2025 increase that pushed borrowing costs to their highest since the mid-1990s.

In June 2025, the BOJ also outlined a plan to gradually reduce its monthly JGB purchases through early 2027, while reserving the right to boost buying and carry out fixed-rate operations if long-term yields jumped too quickly.

At last week’s meeting, the central bank nudged up its growth forecasts for the next two fiscal years and projected that core inflation — which excludes fresh food — would run near its 2% target on average, easing from roughly 2.7% in fiscal 2025 to just under 2% in fiscal 2026. Those projections, along with Takata’s dissent, led some analysts to view the decision as cautiously leaning toward further tightening, with expectations in markets for a possible move to 1% around the spring if wage and price data remain firm.

Snap election brings fiscal stimulus into focus

Yet traders were just as focused on the other end of the capital — the prime minister’s office.

Takaichi, who became Japan’s first female prime minister in October after taking the helm of the ruling Liberal Democratic Party, announced on Jan. 19 that she would dissolve the lower house and hold a general election on Feb. 8. She is seeking a fresh mandate only a few months into her tenure, leading a right-leaning coalition of the LDP and the Japan Innovation Party.

A centerpiece of her campaign is a promise to suspend the 8% consumption tax on food for two years, reducing the rate to zero on groceries and other items that currently enjoy a lower levy than the standard 10% rate. Government officials and independent economists estimate the measure would cost around ¥5 trillion annually in forgone revenue, depending on how it is designed.

“People are struggling with high prices for daily necessities,” Takaichi said in a televised speech unveiling the plan. “We will temporarily lift the burden on food to support households and revive the economy.”

Opposition parties have put forward similar or even broader versions of a food tax cut, turning fiscal giveaways into a central battleground of the campaign. Economists say the result is a rare moment in which virtually all major parties are arguing for looser fiscal policy, even as borrowing costs rise.

“Markets are now being asked to finance more debt at higher interest rates,” said a Tokyo-based fixed income strategist at a European bank. “The combination of monetary tightening and election-driven tax cuts is not something Japan has really tested before.”

Who wins and who loses from higher yields

For households, the immediate effects are mixed. The end of the food tax, if enacted, would cut grocery bills, particularly helping lower-income families that spend a larger share of their income on essentials. On the other hand, the gradual pass-through of higher interest rates will raise borrowing costs for homeowners with floating-rate mortgages and for small businesses that rely on bank loans, though Japan’s rates remain low globally.

Savers and retirees, who have endured years of negligible returns on deposits and government bonds, are starting to see positive nominal yields. But if inflation remains near 2% or higher, the benefit in real terms may be modest.

The impact on financial institutions is also nuanced. A steeper yield curve — with short-term policy rates still below 1% and longer-dated yields above 2% — tends to support bank profitability by widening the gap between lending and funding costs. Bank shares have generally benefited from expectations of higher rates. At the same time, rapid yield moves risk mark-to-market losses on bond holdings, potentially weighing on capital ratios if not carefully managed.

Global ripple effects: from yen swings to U.S. yields

Beyond Japan, the rise in JGB yields is contributing to a broader shift in global bond markets. As Japanese bonds become more attractive, domestic investors such as insurers and pension funds have less incentive to hold lower-yielding U.S. Treasuries or European government bonds. Strategists say that dynamic has helped push the U.S. 10-year Treasury back toward about 4.3% and German 10-year bund yields toward 3% in recent weeks.

The yen, which has been sensitive to interest-rate differentials, saw volatile trading around the BOJ meeting. Market participants reported sharp intraday swings amid speculation that the Finance Ministry was conducting “rate checks” with banks — informal inquiries that sometimes precede direct currency intervention — though officials did not confirm any such steps.

What comes next

For Ueda’s Bank of Japan, the coming months will test whether it can continue to normalize policy without provoking a deeper bond rout. For Takaichi, they will determine whether her offer of tax relief on food — and her broader agenda of higher spending on defense and advanced technologies — can secure a strong parliamentary majority.

Much will depend on whether investors believe Japan can grow fast enough, and keep inflation sufficiently contained, to manage its debt with interest rates no longer near zero. For now, a country that long symbolized the era of free money and ultra-low yields has become a focal point for questions about how much higher borrowing costs the world’s most indebted governments — and their voters — are prepared to bear.