Japan’s bond market has been rattled by sharp yield rises following Prime Minister Sanae Takaichi’s decision to call a snap election and unveil expansionary fiscal pledges, reviving fears about the country’s already heavy debt burden. Investors have responded by dumping Japanese government bonds, triggering volatility that has spilled into global debt markets.
Despite mounting pressure, sources familiar with the Bank of Japan’s thinking say the central bank is unlikely to step in to stabilise bond yields, citing the high costs and risks of intervention, particularly the danger of renewed yen depreciation.
Election Shock and Market Reaction
Japanese government bonds plunged last month after Takaichi pledged to suspend a food levy for two years, a move that heightened expectations of increased government spending. The selloff drove super-long bond yields to record highs in a rout likened by investors to the 2022 “Truss shock” in Britain, when unfunded tax cuts announced by then-prime minister Liz Truss caused a collapse in the gilt market.
As polls suggest Takaichi’s party could secure a landslide victory in Sunday’s election, investors have grown increasingly nervous that she would gain a strong mandate for expansionary fiscal policies. Those concerns have kept pressure on bonds amid broader anxiety about Japan’s worsening fiscal outlook.
BOJ Caught Between Yields and the Yen
The surge in yields has alarmed policymakers at the Bank of Japan, but officials face a delicate balancing act. On one hand, they are wary of sharp rises in long-term interest rates that could destabilise markets. On the other, any aggressive bond intervention risks weakening the yen further at a time when authorities are already struggling to contain currency depreciation.
The dilemma is compounded by the BOJ’s current policy trajectory. Efforts to suppress long-term yields would conflict with the central bank’s gradual rate-hike strategy, which aims to rein in inflationary pressures amplified by a weak currency.
At a policy meeting on January 22–23, BOJ board members warned of one-sided steepening of the yield curve and heightened volatility, particularly in super-long bonds. Governor Kazuo Ueda also raised the tone of concern, describing the pace of yield increases as “quite fast,” while reiterating that the BOJ stood ready to act in exceptional circumstances.
Threshold for Intervention Not Reached
Despite the turbulence, sources say the BOJ views recent market moves as falling short of the extremely high threshold required for direct intervention. While the central bank has tools such as emergency bond-buying operations or adjustments to its quarterly purchase plans, officials believe conditions do not yet warrant their use.
The most drastic option would be suspending or overhauling the bond tapering programme that has been under way since 2024. However, the BOJ would only act in the event of a panic-driven selloff or a destabilising market breakdown requiring it to serve as a market maker of last resort. According to sources, neither scenario has materialised so far.
Former BOJ board member Takahide Kiuchi said the recent rise in yields reflects investor concern over government fiscal policy rather than speculative excess. He stressed that addressing market distrust rooted in fiscal decisions is primarily the government’s responsibility, not the central bank’s.
Governor Ueda reinforced this division of labour by stating that the BOJ and the government would each play their respective roles, implicitly placing responsibility for fiscal-policy-driven yield increases on the government.
High Cost of Stepping In
The BOJ’s reluctance is driven largely by the costs of intervention. Increasing bond purchases would reverse years of effort to shrink its massive balance sheet through tapering. It would also risk dragging the central bank back toward a yield-control regime it abandoned in 2024.
Analysts warn that renewed bond buying could signal a policy reversal, triggering fresh yen selling by convincing markets the BOJ is loosening monetary conditions again. A weaker yen remains a major concern for policymakers, as it pushes up import prices and fuels inflation.
Mari Iwashita, executive rates strategist at Nomura Securities, said pushing down bond yields would send conflicting signals while the BOJ is raising short-term interest rates. She added that intervention could damage the central bank’s credibility by reinforcing fears it is effectively financing government debt.
Calm Before Another Storm?
Some analysts believe current market stability may be temporary. Investor unease over Japan’s fiscal outlook has left the bond market vulnerable to sudden and sharp selloffs, particularly in the super-long segment.
Domestic life insurers, once reliable buyers of long-dated JGBs, are increasingly stepping back and could even become sellers ahead of the March fiscal year-end, potentially exacerbating volatility.
Former BOJ official Nobuyasu Atago said policymakers are likely deeply anxious about the bond market’s fragility. While the BOJ may be forced to act if markets spiral into a free fall, intervening at the wrong moment could intensify panic rather than calm it. Either choice, he noted, would involve significant risk.
Personal Analysis
This episode underscores how Japan’s economic policy framework is being tested by the re-emergence of fiscal activism. Takaichi’s election gamble has exposed the uneasy truce between fiscal expansion and monetary normalisation, a balance that held for years under extraordinary stimulus but is now increasingly fragile.
The BOJ’s reluctance to intervene reflects a hard-earned lesson from decades of market control: once credibility is lost, it is difficult to regain. By holding the line, the central bank is effectively signalling that fiscal policy choices carry consequences that monetary policy cannot endlessly absorb. Yet this restraint comes at a cost. If investors conclude that no backstop exists, even fundamentally driven concerns could snowball into destabilising selloffs.
The coming days after the election may therefore prove decisive. Whether calm prevails or volatility resurfaces will depend less on central bank action and more on how convincingly the next government addresses fears about Japan’s fiscal sustainability.
With information from Reuters.
