TOKYO, Feb 4 (Reuters) – Prime Minister Sanae Takaichi should not count on the Bank of Japan’s help in taming sharp bond yield rises given the huge cost of intervention, including the significant risk of igniting unwelcome yen falls, sources say.
Japanese government bonds (JGB) went into free fall last month, sowing turmoil in global debt markets, after Takaichi called a snap election and pledged to suspend a food levy for two years, stoking fears that increased fiscal spending would add to the nation’s already huge debt pile.
Super-long bond yields rocketed to record highs in a rout reminiscent of the “Truss” shock in 2022, when then-British Prime Minister Liz Truss’ announcement of large, unfunded tax cuts triggered a collapse in gilts and a historic surge in yields.
Growing prospects that Takaichi’s party will score a landslide victory in the election on Sunday, and secure a mandate for her expansionary fiscal policy, have kept bond investors on edge amid concern over Japan’s worsening finances.
The volatility has raised alarm within the central bank, though three sources familiar with its thinking say the risks of intervention in the bond market at this stage outweigh the rewards.
Japanese policymakers face a tricky trade-off having to keep sharp bond yield rises in check, while seeking to prop up the ailing yen through threats of currency intervention.
The challenge puts the BOJ in a bind as any attempt to keep long-term interest rates low would conflict with its gradual rate-hike path, which it hopes would moderate inflationary pressures from a weak yen.
At a policy meeting on January 22-23, one board member called for vigilance over a “one-sided steepening” of the yield curve, while another warned of high volatility particularly for super-long JGBs, a summary of opinions showed.
BOJ Governor Kazuo Ueda also escalated his warning by describing the pace of yield rises as “quite fast,” and repeated the bank’s readiness to act in exceptional circumstances.
THRESHOLD FOR BOND MARKET INTERVENTION NOT MET
While markets have regained a semblance of calm, the bond selloff has turned investors’ attention to whether the BOJ would come to the rescue in the event of a renewed rout after the election.
But the central bank sees recent market moves as falling short of meeting the very high threshold for intervention, say the sources, who spoke on condition of anonymity.
The BOJ has several tools at its disposal such as conducting unscheduled, emergency bond-buying operations, or tweaking the composition of bonds it buys under a quarterly purchase plan.
The last resort would be to suspend or altogether overhaul its bond taper programme, which has been rolling since 2024.
The BOJ would step in only during a panic selloff driven by speculative trade, or a destabilising move that requires the central bank to act as market maker of last resort, the sources said, adding that neither scenario had unfolded so far.
Any intervention would also be temporary, rather than a precursor to a sustained resumption of increased bond buying, to avoid setting a new line-in-the-sand on bond prices, the sources said.
“If bonds are being sold on speculative trading, the BOJ could see scope to intervene. But it’s clear the recent rise in yields reflects market concern over Japan’s fiscal policy,” said former BOJ board member Takahide Kiuchi.
“It’s the government’s job, not the BOJ’s, to deal with the consequences of market distrust over fiscal policy.”
Ueda made the point clear, stressing that the BOJ and government stood ready to play “each of their roles” in dealing with market volatility – putting the onus on the government to deal with any fiscal-policy-induced rise in yields.
CALM BEFORE THE STORM?
The BOJ’s hesitance reflects the high cost of intervention.
Ramping up bond buying would roll back its efforts to reduce its huge balance sheet through a gradual tapering that began in 2024.
Stepping into the bond market would also drag the BOJ back into the bond yield-control policy it ditched in 2024, and risk unleashing a fresh bout of yen selling by giving markets the impression it was loosening policy again, analysts say.
A weak yen has become a headache for policymakers as it pushes up import costs and broader inflation. Japan is scrambling to lift the yen with rate checks and verbal warnings.
“Trying to push down bond yields would send a conflicting message to markets at a time the BOJ is raising its short-term policy rate,” said Mari Iwashita, executive rates strategist at Nomura Securities.
It also puts the BOJ’s credibility on the line by stoking fears it is bankrolling government debt, she said.
Some analysts see current conditions as the calm before the storm with investor concern over Japan’s fiscal outlook making the JGB market vulnerable to abrupt, sharp selloffs.
Domestic life insurers, which were once stable buyers of super-long JGBs, are retreating to the sidelines and may even be forced to sell ahead of the March fiscal year-end, they say.
“I’m sure policymakers are extremely nervous about the bond market now,” said former BOJ official Nobuyasu Atago.
“The BOJ would need to act if markets go into a free fall, but stepping in at the wrong moment could amplify panic and make things worse,” he said. “Either way, it would be an extremely hard decision.”
(Reporting by Leika Kihara; additional reporting by Takahiko WadaEditing by Shri Navaratnam)
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