The Bank of Japan has announced an interest rate hike aimed at easing inflationary pressures. Meanwhile, the Japanese Prime Minister is expanding borrowing to fund an ambitious plan for industrial upgrades and social welfare.
In Tokyo, pedestrians clad in black coats and jackets cross zebra crossings against a backdrop of towering office buildings.
This month, Japanese Prime Minister Sanae Takaichi delivered a speech at an international financial conference in Tokyo, introducing her economic revitalization plan with an unconventional phrase.
"Shut up and just invest in me," Takaichi said, quoting a popular line from the manga "Attack on Titan"—though many in the audience admitted they didn’t grasp its deeper meaning. She then urged, "Japan is back—invest in Japan."
Takaichi promised attendees that her government would stimulate the economy through fiscal spending, but emphasized that such spending must be both "sustainable" and "responsible." She stated that the scale of fiscal investment must be sufficient to drive growth while keeping Japan’s already high debt levels manageable.
Now, the Prime Minister faces a critical test in delivering on this dual commitment.
On Friday, the Bank of Japan raised its benchmark interest rate to 0.75%. While still far below rates in other major economies, this marks Japan’s highest rate since 1995, after decades of near-zero interest rates to combat deflation.
Bank of Japan Governor Kazuo Ueda said at a press conference that future rate hikes would depend on economic performance and price trends.
The central bank’s decision means Japan’s public debt servicing costs will rise further—Japan already has the highest public debt among developed nations. This comes just after Takaichi’s government pushed through a $117 billion economic stimulus package, including household subsidies, increased military spending, and investments in semiconductors and shipbuilding.
More than half of the stimulus funds will be raised through additional government bond issuance.
Most economists believe Takaichi’s spending plan will provide a floor for Japan’s economic growth next year, helping offset the lingering negative effects of U.S. tariff policies. Japan’s economy contracted in the July-September quarter—its first decline in over a year—due to export tariff hikes.
BMI, a research unit under Fitch Solutions, called Takaichi’s spending plan a "substantial fiscal package" and expects it to boost both private consumption and fixed-asset investment. As a result, BMI raised Japan’s 2026 GDP growth forecast from 0.7% to 1.4%.
However, financial markets are increasingly concerned that Takaichi’s expansionary policies could worsen Japan’s already fragile fiscal position—public debt exceeds twice the size of its economy. This worry has triggered a sell-off in Japanese government bonds.
After the Bank of Japan’s rate hike announcement on Friday, long-term bond yields climbed to their highest level in 25 years.
George Goncalves, chief strategist at MUFG, noted that rising debt, rate hikes, aggressive fiscal spending, and tariff policies have created an unpredictable outlook for Japan’s economy.
"Multiple counterbalancing forces are breeding uncertainty," he said, adding that historically, adjusting just one policy variable made its impact "far easier to predict."
Goncalves believes the core market concern is whether Japan’s fiscal expansion can coexist with sustainable debt management. "Japan’s lifeline has always been its long-held zero—or even negative—interest rate policy."
This is partly why Takaichi has long advocated loose monetary policy.
A supporter of former Prime Minister Shinzo Abe’s "Abenomics," she argues that low rates encourage businesses and households to borrow, spend, and invest while reducing debt servicing costs for stimulus measures. Takaichi once called the idea of a Bank of Japan rate hike "utterly foolish."
After raising rates to 0.5% in January 2025, the Bank of Japan held steady—until recently, when both the central bank and Takaichi’s government shifted focus to the yen’s prolonged weakness under low rates.
At Friday’s press conference, Governor Ueda said several policy board members expressed concerns about the impact of yen depreciation on overall prices. "They noted this issue requires close monitoring."
In January, the Bank of Japan had raised rates but kept them steady afterward due to economic uncertainty.
The wide interest rate gap between Japan and other major economies is a key factor behind the yen’s persistent decline. While a weaker yen boosts exports, it also raises import costs, fueling inflation. Data released Friday showed Japan’s inflation rate has exceeded the central bank’s 2% target for 44 consecutive months.
Persistent inflation has dampened consumer spending, with price growth outpacing wage increases every month this year.
Markets widely see the Bank of Japan’s latest hike as an effort to narrow rate differentials, strengthen the yen, and ultimately curb inflation while allowing wages to catch up. The central bank and Takaichi’s government hope this indirect approach will revive consumption.
However, Stefan Angrick, senior economist at Moody’s Analytics, warned that hiking rates solely to counter yen weakness carries risks. "Tighter monetary policy also suppresses corporate investment and household spending," he wrote in a recent report.
On Friday, the yen weakened slightly against the dollar.
Governor Ueda noted that previous rate hikes lifting rates above zero had not "exerted excessively strong tightening effects." As for future moves, he said, "After raising rates to 0.75%, we will assess economic, financial, and price developments."
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