The Bank of Japan is moving closer to what many market participants view as an early interest-rate increase, but political dynamics tied to Japan’s fiscal stance are complicating that path. As government spending proposals lift long-term yields, policymakers in Tokyo face an intensifying tug-of-war between the central bank’s push to normalize policy and political demands to stabilize the bond market through renewed purchases.
Officials aligned with Prime Minister Sanae Takaichi’s reflationist agenda have publicly flagged concern about rising Japanese government bond (JGB) yields and the BOJ’s decision to pare back its balance sheet. That unease comes as yield increases raise borrowing costs for Japan, which carries one of the largest developed-world public debt burdens, and have drawn attention from overseas markets.
Takaichi has taken steps intended to reassure investors about Japan’s fiscal health. Last month she pledged to strengthen communication with markets to preserve confidence in the country’s finances. Domestic reports said that during a May meeting she urged BOJ Governor Kazuo Ueda to step up bond buying when necessary to contain increases in long-term rates. Subsequent public comments from allies have reinforced the administration’s sensitivity to higher yields and to the pace of the BOJ’s balance-sheet reduction.
In July, a close aide described as reflationist said the administration paid "very high" attention to movements in bond yields and had conveyed investor unease about what it termed the BOJ’s "too-rapid" pace of balance-sheet reduction. Toshihiro Nagahama, who was reportedly chosen by the prime minister to join a government advisory panel, observed that the administration emphasizes the quantitative dimension of monetary policy over conventional tools such as interest-rate hikes.
Economy Minister Minoru Kiuchi, another ally associated with reflationist thinking, warned of the economic consequences of the BOJ’s balance-sheet shrinkage and urged a policy emphasis on market stability, according to minutes of the BOJ’s June policy meeting. For some observers, such political pressure has already shaped central bank decisions. They point to the June choice to combine a rate increase with a pause in the bank’s bond-tapering programme set to begin in the next fiscal year.
There is an active policy debate in Tokyo about how far the BOJ should go in normalizing policy when public finances and market functioning are under strain. Some analysts and former officials warn that asking the central bank to resume large-scale bond purchases as long-term yields climb could do more harm than good.
"Demanding the BOJ to buy bonds when long-term rates are rising would backfire by stoking concerns over fiscal dominance and casting doubt on the central bank’s ability to combat inflation," said former BOJ official Nobuyasu Atago.
Takaichi, who is often associated with the late former premier Shinzo Abe’s pro-growth, asset-buying approach to reflation, has supporters who favor policies that reflate the economy through stronger demand-side and quantitative measures. For the BOJ, however, reverting to large-scale bond purchases would represent a sharp reversal of a long-running effort to exit extraordinary accommodation.
The BOJ ended its yield-curve control regime in 2024 and initiated a bond-tapering programme as part of a broader normalization strategy. A U-turn back to extensive buying now would risk undermining the credibility of that shift and could impede the revival of a private bond market that had been suppressed by prolonged central-bank purchases.
Bank officials have said they would only increase bond purchases through emergency operations if yield moves became disorderly and disconnected from underlying economic fundamentals in a way that threatened financial stability. The BOJ has also been seeking to strengthen its case for continued normalization by emphasizing the role of rising inflation in driving yields higher, rather than attributing the rise primarily to tapering.
In a research paper released recently, the BOJ argued rising inflation was the principal force behind higher bond yields. Minutes from the June policy meeting recorded that board members had begun internal discussions about an eventual target size for the BOJ’s balance sheet, an indication that the bank remains committed to normalization despite political pushback.
Atago suggested those detailed internal debates could presage publication of estimates for an ultimate balance-sheet objective. Releasing such analysis, he said, could help the BOJ rebut claims that it was adjusting the pace of bond purchases in response to government pressure rather than on the basis of monetary-policy criteria.
Markets, however, may exert their own pressure. Investors remain wary about the expansionary aspects of the government’s fiscal package, and that concern continues to push yields higher. The 10-year JGB yield reached 2.805% on Monday, moving closer to the roughly 3% level that some market participants view as a potential trigger for intensified selling.
While the BOJ has no explicit target for a particular yield level, officials have signalled they could step in if moves become rapid and one-sided enough to threaten financial stability. A policy source familiar with the bank’s thinking said intervention would be considered if market dysfunction emerged.
Mari Iwashita, executive rates strategist at Nomura Securities, warned that the BOJ may have limited options if domestic investor demand for bonds weakens and drives yields sharply higher. "The BOJ could have no choice but to step in if a dearth of demand for bonds among domestic investors triggers a spike in yields," she said, adding that this is the cost of the BOJ having dominated the bond market for an extended period through prolonged monetary loosening.
The central bank’s next moves will be watched closely for signs of whether it will maintain its normalization trajectory amid political pressure, or tilt toward renewed market support to blunt near-term spikes in yields. For now, internal discussions about balance-sheet size and the emphasis on inflation as a driver of yields indicate the BOJ is preparing to defend the technical rationale for its policy course even as government voices press for greater market stability.