ICYMI - Rising yields force Japan to budget for higher debt-servicing costs

Summary

• Japan plans to assume a 3% interest rate on bond expenses in its FY26 budget

• The assumption reflects rising JGB yields and BOJ policy normalisation

• It marks the highest budgeted rate in roughly two decades

• Higher debt-servicing costs could constrain fiscal flexibility

• The move signals a more realistic acceptance of a higher-rate environment

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Japan’s government is reportedly planning to budget for a ~3% interest rate assumption on its long-term government bond expenses in the FY2026 budget, the highest assumed rate in about two decades. The news dribbled out overnight and its getting a rerun in markets here in Asia.

This rate assumption is used when the Ministry of Finance builds the budget to estimate how much it will cost to service Japan’s huge public debt, i.e., the interest payments the government expects to make on its outstanding bonds.

There are a few key drivers behind this jump in assumed rates:

1. Rising market yields

• Market yields on Japanese government bonds (JGBs) have climbed sharply as bond markets repriced in anticipation of tighter monetary policy and reduced central-bank support. Longer-dated yields, including 30-year JGBs, have already exceeded 3% in the market, the highest since they were introduced.

2. BoJ normalisation

• With the Bank of Japan raising policy rates to 0.75%, the highest in 30 years, and gradually shrinking yield-curve support, market pricing for longer-term rates has moved materially higher.

3. Fiscal pressures and spending plans

Japan’s national debt is among the highest in the developed world, above 230% of GDP, and recent large fiscal packages under Prime Minister Sanae Takaichi have reinforced market concerns about debt sustainability.

Fiscal impact

Assuming higher interest costs in the budget means the government is preparing for greater debt-servicing expenses, even without issuing significantly more bonds. That can crowd out spending on other priorities and tighten fiscal flexibility.

Market realism

A 3% assumption signals that Tokyo is acknowledging higher global and domestic real yields, rather than clinging to artificially low cost forecasts. This can build investor confidence — or at least reduce the likelihood of surprise — but also reflects a harsher financing environment.

Yields and the yen

Higher assumed rates in the budget tend to correlate with higher real yields in markets. If markets truly price longer-term JGB yields around 3% or more, it can underpin flows into JGBs but also support a stronger yen, as higher real rates make yen assets more competitive. However, commentary suggests the FX impact has been uneven, in part because of expectations around BoJ’s future path and policy signalling.

Debt sustainability narrative

Budget assumptions rising to 3% underline a broader shift in Japan’s macro narrative: from decades of ultra-low rates and easy financing, toward a gradual repricing of risk and cost, both domestically and globally.

Bottom line

This isn’t just bookkeeping. It’s a visible marker that the market’s repricing of Japanese bond yields, driven by BoJ normalisation and fiscal realities, is now being baked into the government’s budget framework. That has implications for fiscal policy, JGB markets, and the broader narrative about Japan’s macroeconomic transition. 2026 is gonna be lit!