Japan’s record yields on Japanese government bonds pose a political problem for the BOJ

Japan’s central bank is in a bind as rising government bond yields risk upending its monetary policy normalization process.

The Bank of Japan faces a difficult decision: either stick to its policy of raising interest rates and risk even higher yields and further slowing the already weak economy, or maintain or even lower interest rates to support growth, which could further boost inflation.

Japanese government bonds hit new highs last month. On Thursday, the 10-year Japanese government bond yield hit a high of 1.917%, rising to its highest level since 2007. The 20-year Japanese government bond yield reached 2.936%, a level not seen since 1999, while the 30-year government bond hit a record high of 3.436%, LSEG data from 1999 showed.

Japan abandoned its yield curve control program in March 2024, capping benchmark 10-year bond yields at around 1%, as part of its policy normalization that also saw the country end the world’s last negative interest rate regime.

Now, as the country considers raising interest rates at a time when inflation has risen – it has remained above the BOJ’s 2 percent target for 43 straight months – the specter of a further rise in bond yields looms.

Anindya Banerjee, head of currency and commodities at Kotak Securities, told CNBC’s “Inside India” that if the BOJ returns to quantitative easing and YCC caps bond yields, the yen could also weaken and fuel imported inflation, which is already a problem.

Rising bond yields mean higher borrowing costs for Japan, further straining the country’s fiscal situation. Asia’s second-largest economy already has the world’s highest debt-to-GDP ratio, at nearly 230%, according to data from the International Monetary Fund.

Add to this the fact that the government is poised to roll out its biggest stimulus package since the pandemic to lower the cost of living and shore up Japan’s struggling economy, and concerns about Japan’s skyrocketing debt are only growing.

Magdalene Teo, head of Asia fixed income research at Julius Baer, said the new 11.7 trillion yen bond issuance to finance Prime Minister Sanae Takaichi’s supplementary budget was 1.7 times larger than the bond issued under her predecessor Shigeru Ishiba in 2024.

“This highlights the government’s difficulties in balancing economic stimulus initiatives with maintaining financial sustainability,” Teo said.

In August 2024, an unwinding of yen-funded leveraged carry trades Due to a restrictive interest rate hike by the BOJ and disappointing macro data from the US, there was a sell-off in stocks worldwide, including in Japan Nikkei plunged 12.4%, its worst day since 1987.

Carry trade is the practice of borrowing in a currency with lower interest rates and investing in high-yield assets, with the Japanese yen being the predominant currency for financing such deals as the country follows a negative interest rate policy.

Now rising Japanese yields have narrowed that interest rate differential, fueling concerns about another round of carry trade unwinding and repatriation of funds to Japan. However, experts believe a repeat of the 2024 meltdown is unlikely.

“From a global perspective, the narrowing yield gap between Japan and the U.S. reduces the attractiveness of yen-funded carry trades, but we do not expect a repeat of systemic easing in 2024… Instead, expect episodic volatility and selective deleveraging, particularly if yen strength accelerates funding costs,” said Masahiko Loo, senior fixed income strategist at State Street Investment Management.

Loo cites said structural flows driven by private allocations from pension funds, life insurance and NISA (Nippon Individual Savings Account) that anchor foreign holdings, making large-scale repatriation unlikely.

Justin Heng, APAC interest rate strategist at HSBC, agreed, saying Japanese investors had shown little sign of repatriating funds and continued to be net buyers of foreign bonds.

According to HSBC, they bought 11.7 trillion yen worth of foreign debt from January to October 2025, far exceeding the 4.2 trillion yen purchased in all of 2024. This increase was mainly driven by trust banks and asset managers, which benefited from retail inflows under the Japanese government’s tax-free investment program.

“We expect that the continued decline in hedging costs as a result of further Fed rate cuts is also likely to encourage Japanese investors to take more exposure to foreign bonds,” Heng said.