Deutsche Bank said Japan may have to shift its focus from supporting the yen to controlling government bond yields if it wants to achieve its ambitious economic growth plan.
Marika Sakhdar, the firm’s strategist, wrote in a report that Japan’s Prime Minister Sanae Takaichi’s recently announced 2.3 trillion yen growth strategy at the end of last month has placed Japan “on the verge of a major shift in fiscal and industrial policy.” “Japan must find room to increase spending while maintaining fiscal sustainability,” she said.
The growth plan requires a significant increase in spending, which authorities aim to finance by mobilizing domestic savings and encouraging large institutional investors to allocate more funds to domestic assets. At the same time, they need to maintain nominal economic growth above financing costs. Sachdeva said achieving both goals may require measures to control yields.
This will mark a shift in Japan’s central bank policy. The Bank of Japan and the government have been striving to curb the yen’s decline, including through large-scale interventions in the foreign exchange market. However, the yen has responded tepidly to these efforts, falling this week to a 40-year low before recovering slightly. Earlier, Bloomberg News reported that BOJ officials are open to raising interest rates at a pace faster than what economists generally expect.
Sahdeva said, “If fiscal capacity becomes the most important policy criterion, incentives may shift from foreign exchange management to yield management—from constraining the dollar/yen exchange rate to limiting 10-year government bond yields and borrowing costs.”
Controlling the yield curve to lower borrowing costs was a strategy Japan employed between 2016 and 2024. Other countries have also used this approach, including the United States, which utilized it during World War II to raise funds for military spending.
Sahdeva said Japan is not the only developed country struggling to revive economic growth due to massive debt. However, with its debt-to-GDP ratio exceeding 200%, Japan’s fiscal space is far smaller than that of other countries, and this indicator has already reached a very low level.
Concerns about debt sustainability have pushed bond yields higher this year, with 30-year borrowing costs reaching a record high.
Sahdeva expects Japan to manage long-term yields primarily by influencing bond demand, including authorizing the Government Pension Investment Fund—Japan’s “biggest weapon”—to increase domestic investments, with a scale of up to $1.8 trillion. Additionally, Japan could encourage the Bank of Japan to support yield management by taking a more active role in the bond market, such as resuming bond purchases. Alternatively, Japan might urge the central bank to maintain an accommodative monetary policy.
She pointed out that the latter two scenarios could put pressure on the yen, while the return of some of GPIF’s overseas assets would support the yen exchange rate.
She added, “Measures to suppress yield volatility could come with greater fluctuations in the foreign exchange market.”
