Japan’s Bond Yields Hit 25-Year High as BOJ Signals Caution and PM Calls Snap Election

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.

BOJ holds rates as long-term yields surge

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 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 GDP—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. “If such moves deviate from economic fundamentals or become excessive, the Bank will respond flexibly through its market operations.”

The 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, underscoring a growing split over how quickly to move away from the ultra-easy stance that has defined Japanese monetary policy for years.

Outlook points to a pause—not an end

In its quarterly outlook, the BOJ 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 (excluding fresh food) to run at around 2.7% in fiscal 2025 before easing to just under the 2% target in 2026.

Those projections, together with an explicit call for a hike from within the board, led many analysts to view 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 BOJ has spent the past two years engineering a slow exit from negative rates and yield-curve control, ending negative rates in March 2024 and raising its key rate in stages, while outlining plans to shrink its massive JGB purchases.

Ueda has repeatedly emphasized an escape clause: if long-term yields spike too quickly, the bank is prepared to intervene 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 with concern.

Snap election adds fiscal uncertainty

The monetary policy message arrived 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, 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.

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 (more than $30 billion), though final costs 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.

Opposition parties have floated their own versions of food-tax relief, turning fiscal loosening into one of the few areas of campaign consensus even as Japan’s debt load continues to rise.

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% is held domestically, and the BOJ owns close to half of outstanding JGBs.

Market consequences at home—and abroad

A steeper yield curve can help banks and life insurers by improving net interest margins, but rapid moves are inflicting mark-to-market losses on portfolios heavy in long-duration JGBs.

For households, the impact is mixed. Many mortgages and small-business loans are tied to variable rates, meaning borrowing costs are expected to drift higher as policy normalizes. Savers, meanwhile, are beginning to see slightly higher returns after years of near-zero yields.

The JGB sell-off is also reverberating through global debt markets. Strategists say rising Japanese yields are one factor pushing U.S. 10-year Treasury yields toward about 4.3% and German 10-year bund yields close to 2.9%, 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 home-market returns continue to improve, demand for foreign bonds could soften, keeping upward pressure on global borrowing costs.

A test of policy coordination

For now, the BOJ is signaling patience. Ueda said officials would monitor the effects of the December rate hike and subsequent market moves carefully before deciding on further adjustments, reiterating 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 Feb. 8 vote will determine whether Takaichi secures 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.