Japan’s fiscal indiscipline amid rising inflation could undermine the bond market, the head of top lender Mitsubishi UFJ Financial Group said, amid market expectations of an imminent end to ultra-low interest rates.
The 10-year Japanese government bond (JGB) yield hit a ten-year high of 0.805% this week, nearing the Bank of Japan’s hard cap of 1.0%, partly amid growing speculation that the bank will soon wind down its massive stimulus programme.
Global bonds have been actively traded for weeks, prompting the BOJ to step in to support the JGB market as investors expect interest rates around the world to remain elevated.
While the central bank maintains ultra-soft monetary policy based on the assessment that sustainable inflation of 2% has yet to be achieved, the government seems intent on further expanding spending designed to cushion the effects of inflation.
Japan in particular stands out from the US, where government debt obligations are under scrutiny.
Rising wages and strengthening corporate inflation expectations suggest that price dynamics in Japan are changing.
As these factors combine to raise the risk that the policy response will “lag”, the Bank of Japan may move to remove negative interest rates as early as January, when the prospects for wage increases at large companies become clear.
Under the negative interest rate policy, the BOJ applies an interest rate of -0.1 per cent to the small pool of excess reserves that financial institutions hold at the central bank. In addition, under a policy dubbed yield curve control (YCC), the yield on 10-year government bonds is kept at 0% with a hard cap of 1.0%.
Even if the Bank of Japan raises short-term rates, it will probably have to maintain the YCC framework to avoid a sharp rise in long-term interest rates.
The Japanese government, saddled with the largest debt in the industrialised world, more than twice the size of the country’s $5 trillion economy, has benefited from low borrowing costs over the past decade, helped by the central bank’s ultra loose monetary policy.