Tokyo [Japan], February 22: After decades of deflationary stagnation and exceptionally low interest rates, Japan has entered a new macroeconomic regime. Following the Covid-pandemic and the Russia-Ukraine war, the "supply shocks" of confinement measures and geopolitical disruptions, combined with the global surge in commodity prices fuelled prices in Japan. These events amplified with a large "demand shock" from an unprecedented boost from significant fiscal support with ultra-loose monetary policy, pushing up the prices of goods.
After major central banks began to hike interest rates to bring inflation under control, the interest rate gap with Japan widened, while the Bank of Japan (BoJ) maintained its "ultra loose" monetary policy with a negative short-term policy rate of -0.1 percent. As a result of this gap, the Japanese Yen (JPY) depreciated sharply, inducing a wave of renewed price pressures, pushing inflation above 4 percent in early 2023, a level that had not been reached in over three decades.
To bring inflation under control, the BoJ started a historic process of monetary policy normalization, finally ending negative rates for the first time in 17 years. Since 2024, the BoJ has increased the policy rate 4 times, for a total of 85 b.p. Additionally, the BoJ has formally ended its Yield Curve Control (YCC) programme, removing the cap on the 10-year JGB (Japanese Government Bond) yield and shifting to a more flexible framework. With the end of YCC, the BoJ began to scale back its purchases of JGBs: from monthly bond purchases close to JPY 9 Tn at their peak in 2023, to around JPY 3 Tn, with further gradual reductions planned.
In this context, long-term JGB yields increased considerably from the levels of previous years. The benchmark 30-year JGB yield has risen by more than 2.5 percentage points (p.p.) to above 3.6 percent, the highest level in decades. In this article, we discuss the key drivers that explain the rise in long-term JGB yields.
First, the rise in Japanese yields reflects the structural shift in Japan's macroeconomic drivers, from an environment dominated by deflationary forces to a more "reflationary" period where growth and inflation are normalised. The initial external shocks from higher imported inflation rapidly affected the domestic economy dynamics, contributing to break the long-standing deflationary trend.
The annual "Shunto" wage negotiations, for example, a key determinant of the country's wage dynamics, have delivered wage increases of around 5 percent, the highest in several decades. In a context of acute labour shortages, these wage gains strengthened expectations that inflation has undergone a permanent upward level adjustment.
Higher inflation, alongside higher real GDP growth from strong exports and a corporate investment revival, helped boost nominal GDP growth.
In fact, while annual nominal GDP growth averaged 0.1 percent between 2000 and 2020, this figure has accelerated many-fold to an average annual growth of 3.7 percent for the 2021-2025 period. As a result, investors have revised their assessment of the equilibrium interest rates, pushing up longer-dated yields.
Second, the emergence of Prime Minister Sanae Takaichi in October 2025 consolidated the perception that higher nominal growth is set to continue over the coming years in Japan. Takaichi supports more aggressive fiscal policies aimed at securing stronger growth and industrial policy, and for de-prioritizing debt reduction and central bank independence. Takaichi's victory strengthened expectations of more robust economic growth and higher inflation, especially if fiscal policy becomes more expansive. Long-dated bonds, and particularly ultra-long ones of more than 30-years of duration, are highly sensitive to nominal growth, and the assumption of near zero nominal growth appears to have been broken.
Third, regulatory changes and balance sheet considerations have reduced private institutional domestic demand in the JGB market. Japanese regulation is transitioning from a solvency regime based on book-value to a market-based framework. The new regime penalises interest-rate risk and duration mismatches.
As a result, traditional domestic investors in JGB, particularly life insurers, have scaled back their demand. This has a significant impact on the JGB market given that life insurers, which previously absorbed around 35 percent of net issuances for long JGB, have reduced purchases by several trillion JPY per year. The weaker demand from life-insurers amid regulatory changes has contributed to the increase in long-term JGB yields.
All in all, the increase in longer-term JGB yields is a result of a structural shift in nominal growth, amplified by country leadership changes and reduced institutional demand amid regulatory changes. In our view, this reflects Japan's transition towards a more conventional monetary and macroeconomic environment after decades of deflationary dynamics.
Source: Qatar Tribune
