Japan Government Bond Yield at Multi-Decade High, BOJ Faces a Stagflation Dilemma

Concerns Mount Over Higher Neutral Rate, Acceleration of Yen-Carry Unwinds
Government Hit Directly as JGB Issuance Surpasses About $7.5 Trillion
Real Wages Decline and Consumption Contracts, Economy Shrinks for First Time in Six Quarters

Japan’s 10-year government bond yield is closing in on the 2% threshold, rapidly heightening market anxiety. As expectations for additional rate hikes by the Bank of Japan intensify, long-term yields are moving first, and the government’s large-scale stimulus program is amplifying concerns over expanded issuance and rising interest burdens. The yield uptrend carries major implications: it risks triggering another wave of yen-carry unwinds, strengthening the yen and reshaping global capital flows. Combined with inflation, weak real wages, and slowing growth, the strain on Japan’s economy is becoming increasingly pronounced.

10-Year JGB Yield Nears 2%

According to the Tokyo bond market on the 10th, the newly issued 10-year Japanese government bond yield stood at 1.960% as of 3 p.m., down 0.01 percentage point from the previous session. The newly issued 20-year yield rose 0.005 point to 2.955%. The 10-year yield alone has climbed about 0.2 percentage point this month. The yield briefly surged to 1.970% the previous day during intraday trading. A 10-year yield in the 2% range would mark the highest level since May 2006—19 years and seven months.

The catalyst behind rising yields is the prospect of rate hikes. Markets now expect the BOJ to raise its policy rate—currently at 0.5%—to around 1.4%. BOJ Governor Kazuo Ueda said at a financial and economic meeting on December 1 in Nagoya, Aichi Prefecture, that he would “appropriately assess the need for additional rate hikes,” remarks widely interpreted as signaling a potential rate increase in December. Assuming the BOJ proceeds with tightening, long-term yields are climbing in tandem.

The BOJ began its exit from negative rates last March by raising its policy rate to 0.1%. It followed with another hike to 0.25% in July the same year, jolting global markets. At the time, the combination of BOJ tightening and deteriorating U.S. employment data triggered an unwinding of yen-carry trades, which cascaded into a sharp equity sell-off culminating in the Black Monday of August 5. Although some argued the rate increase itself was marginal, markets were fixated on the BOJ’s shift in direction. The mere fact that Japan was entering a tightening cycle was enough to elicit an immediate global reaction.

Today’s macro environment is increasingly mirroring conditions during past unwinding episodes. Once unwinding begins, global markets experience chain reactions. The first response is a rapid yen surge. In risk-off conditions, the yen is among the fastest-appreciating currencies worldwide. Carry traders repurchase borrowed yen to close positions, triggering further short-covering and additional yen appreciation. The stronger yen, in turn, worsens investor sentiment and sets off a broader wave of global market instability.

Interest Burden and Valuation Losses Amplify Impact

The entity most exposed to rising rates is the Japanese government, which has issued the equivalent of more than $7.5 trillion in government bonds. For years, the government relied on ultra-low funding costs under the BOJ’s negative-rate regime; rising rates now translate directly into surging debt-service costs. These pressures are compounded by an expansionary fiscal stance under the Sanae Takaichi administration. The government recently unveiled a stimulus package totaling the equivalent of about $290 billion in fiscal spending and about $580 billion overall. Despite Japan’s high debt ratio, the administration opted to prioritize growth, making additional bond issuance unavoidable.

Rising interest expenses are not the only concern. Japan has earned a reputation for superior yield-curve control relative to other central banks. The BOJ long touted its toolkit of unconventional policies—quantitative easing and yield-curve control foremost among them. Such control was possible largely because Japan was entrenched not in inflation but in deflation. Today, however, Japan is preparing for rate hikes amid an inflationary environment while simultaneously buying government bonds to counter surging yields—a policy contradiction.

Regional banks that concentrated on long-duration securities during the low-rate era are also suffering mounting valuation losses as yields rise. The longer the maturity, the deeper the price declines when rates move higher. As of the end of September, valuation losses on JGBs and local government bonds held by regional banks had reached the equivalent of about $223 billion. These banks had posted valuation gains of about $17 billion at the end of 2020, but rising yields have swung their books into losses. While these are accounting losses that do not materialize if bonds are held to maturity, large unrealized losses restrict the ability to sell holdings and reinvest in higher-yielding instruments, raising questions about capital soundness and posing risks to broader financial stability.

Rising rates are also lifting mortgage burdens. For example, borrowing the equivalent of about $340,000 at a fixed 2% rate for 35 years results in total repayment of about $470,000, roughly $70,000 more than at a 1% rate. Corporate borrowing costs are rising as well. According to estimates by Tokyo Shoko Research, a 0.25-percentage-point increase in average borrowing rates raises annual interest expenses per company by the equivalent of about $4,700 and reduces ordinary profits by an average of 2.1%. Roughly 1.8% of all firms are projected to fall into operating losses as a result.

Inflation and Negative Growth Occurring Simultaneously

Yet the BOJ cannot avoid raising rates. Inflation shocks are becoming more pronounced. According to Japan’s Ministry of Internal Affairs and Communications, core consumer prices rose 3% in October from a year earlier. The inflation rate had dipped into the 2% range in August and September but returned to the 3% range after three months. Kyodo News reported that “persistent inflation continues to squeeze households,” adding that despite government measures, “yen weakness clouds the outlook for stabilizing prices.”

Real consumption is also weakening. The ministry reported that real household spending in October fell 3% year-on-year, turning negative for the first time in six months and marking the lowest figure since January 2024. Markets had expected a 1% increase, but a series of food-price hikes dampened consumer sentiment. Analysts say households have little room left to further reduce food spending, meaning cutbacks are now spreading to education, housing, and durable goods—adding further pressure on the economy.

Real wages have also declined under persistent inflation. According to the Ministry of Health, Labour and Welfare, real wages in October fell 0.7% from a year earlier, marking ten consecutive months of decline. Nominal wages averaged the equivalent of about $2,130, up 2.6% from a year earlier, but inflation pushed real wages into contraction. As a result, Japan’s economy shrank for the first time in six quarters. On December 8, the Cabinet Office reported that third-quarter real GDP fell 0.6% from the previous quarter, or 2.3% on an annualized basis—worse than the preliminary figures of -0.4% and -1.8%.

The combination of negative growth and high inflation is a classic stagflation scenario, but Japan’s case is distinct. Rather than a supply shock alone, fiscal deterioration and ballooning JGB issuance are constraining rates, prices, and growth simultaneously—conditions that cannot be eased simply by external stabilization. A senior economist noted that “without a clear recovery in real wages, the BOJ lacks both the justification and the buffer needed for further tightening,” adding that “with market rates already rising and tightening financial conditions, the BOJ may tilt toward a wait-and-see stance rather than pushing policy further.”