Japan – what the rise in yields means

Yields significantly higher and yen weaker, ...

The Japanese financial markets had a turbulent start to the new year. Interest rates on 30-year government bonds shot up by almost 40 basis points in the week leading up to January 20, before the market calmed down again. These securities are currently yielding slightly higher than their German counterparts. The yen was also under pressure for a long time until it recently stabilized due to rumors of intervention. What is behind these violent market movements?

... because inflation has returned ...

Although the strength of the recent rise in yields was exceptional, the upward trend is not new. In fact, yields have been trending upward for several years. The reason for this is likely to be found in the return of inflation. For many years, Japan was considered by many to be a prime example of an economy trapped in deflation. Excluding food and energy, the inflation rate remained almost exclusively in negative territory for the first 13 years of this millennium, averaging -0.5% per year. Two economic shocks brought this phase to an end:

• In 2013, then-Prime Minister Abe initiated a drastic change of course in economic policy to halt the decline in consumer prices. In doing so, he focused in particular on an aggressive monetary policy, while the budget deficit actually tended to decline under his leadership. The Bank of Japan (BoJ) kept key interest rates close to zero until 2024. Above all, however, it purchased large quantities of government bonds worth around 100% of gross domestic product (GDP), making these purchases far more extensive than those in the US or the eurozone. Entrenched inflation expectations began to change. Wages, which had fallen by around 0.7% per year since the turn of the millennium, began to rise slightly again. The inflation rate was slightly positive from 2013 to the end of 2019, even when adjusted for the effects of the significant VAT increase in 2014.
• The Japanese government responded to the coronavirus pandemic and the resulting strain on the economy with an extremely expansionary fiscal policy, which caused the primary deficit – i.e., the budget balance excluding interest payments on existing government debt – to jump from around 3% to around 9% of gross domestic product. This was accompanied by an expansionary monetary policy. Because the macroeconomic demand thus stimulated met with a coronavirus-induced contraction in the supply of goods and services, the core inflation rate climbed to almost 3% by the end of 2024 and then settled at around 1.5%.

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