TOKYO, Dec 23 — Japan could face further declines in the value of its currency, the yen, alongside a continued increase in bond yields, fueled by market anxieties surrounding the government’s expansionary fiscal policies, according to former Bank of Japan policymaker Seiji Adachi.
Yen Weakness Tied to Fiscal Concerns, Not Just BOJ Policy
Market doubts about Japan’s financial stability are driving down the yen, despite recent interest rate hikes, a former central bank official warns.
- The yen has weakened even after the Bank of Japan raised interest rates to 0.75 percent on Friday.
- Investors are increasingly concerned about Japan’s ability to manage its public finances.
- The benchmark 10-year government bond yield reached a 27-year high of 2.1 percent on Monday.
- Further interest rate increases, potentially up to 1.5 percent by July, could strain Japan’s public debt.
The yen’s recent struggles aren’t simply a result of interest rate differences between Japan and the United States; rather, investors are beginning to demand a higher return to compensate for perceived fiscal risks within Japan, Adachi explained in an interview on Monday. What is driving the yen’s decline? Concerns over Japan’s fiscal health, not just Bank of Japan policy, are the primary factor.
“The yen is weakening despite narrowing Japan-U.S. interest rate differentials, which means it has little to do with BOJ policy,” Adachi said. “I think investors are starting to demand a higher premium for Japan’s fiscal risk,” a trend reflected in the rising yields on Japanese government bonds (JGBs).
On Monday, the benchmark 10-year JGB yield climbed to 2.1 percent, a 27-year high, signaling expectations of further rate hikes by the Bank of Japan and increased government borrowing.
Debt Concerns Loom Large
Adachi anticipates the Bank of Japan may eventually raise interest rates to as high as 1.5 percent, with the next increase potentially occurring around July of next year. However, this tightening cycle would simultaneously increase the cost of servicing Japan’s substantial public debt, a burden expected to grow under Prime Minister Sanae Takaichi’s ambitious fiscal plans.
Next fiscal year’s budget, the first under Takaichi’s leadership, is projected to surpass 122 trillion yen ($781 billion), setting a new record and necessitating additional bond issuance exceeding the previous year’s 28.6 trillion yen, according to the Nikkei newspaper.
This anticipated budget comes in addition to a 21.3-trillion-yen stimulus package already approved for the current fiscal year, designed to mitigate the impact of rising living costs on households.
The Bank of Japan may be compelled to reassess its bond-tapering strategy if the bond market selloff persists, or even devise a plan to support smaller banks facing significant losses on their bond holdings, Adachi cautioned.
“It’s hard to erase market doubts over Japan’s finances after Takaichi so powerfully branded her policies as proactive fiscal policy,” he stated. “Rising bond yields will be the biggest risk to Japan’s economy next year.”
($1 = 156.2700 yen)
