A ¥3 trillion supplementary budget has reignited fears over Tokyo's debt trajectory
Rising bond yields are rattling investor confidence in Prime Minister Sanae Takaichi's ability to manage Japan's debt pile.
According to CNBC, the 30-year government bond yield crossed 4 percent and the 10-year equivalent hit a 30-year high of 2.809 percent on May 20.
The trigger: a roughly 3tn yen (approximately US$19bn) supplementary budget Takaichi announced to subsidise fuel costs and ease cost-of-living pressures linked to the Middle East conflict, Reuters reported.
The package reversed her earlier position that extra spending was not needed.
She said total bond issuance for calendar year 2026 would remain unchanged from the original budget plan, Bloomberg reported, but market observers were not persuaded.
Jesper Koll, expert director at Tokyo-based Monex Group, told CNBC that bond markets are pricing in Japan's fiscal risks clearly, warning that higher spending cannot come without higher debt.
Koll also called the calendar-year framing of fiscal targets unprecedented in Japanese policymaking and said it amounted to a red flag.
She argued a larger, transparent fiscal package would have been more credible, saying a hypothetical 10tn yen budget backed openly by bonds would have earned market trust.
The current approach, he said, has not.
Louis Chua, Julius Baer's Asia equity research analyst, told CNBC that Middle East uncertainty, high commodity prices and rising fuel subsidy costs have compounded bond market concerns about Japan's fiscal outlook.
Not all analysts see the budget as destabilising.
The package looked "less like broad stimulus and more like targeted cushioning for households facing energy-driven price pressures linked to the Iran conflict," State Street Investment Management APAC economist Krishna Bhimavarapu told CNBC.
He said it aligned with Takaichi's fiscal philosophy rather than signalling a large-scale demand boost.
Reuters said the BOJ is now weighing whether to pause its quantitative tightening programme in fiscal 2027, which runs from April.
The central bank has been gradually reducing monthly bond purchases since 2024 under Governor Kazuo Ueda's normalisation push, and will review its taper plan at the June 15-16 meeting.
A pause is increasingly seen as the preferred option among those familiar with the deliberations with the Iran conflict keeping markets jittery.
"Markets remain volatile, so there's no need to rush," one source told Reuters.
A rate hike to 1 percent from 0.75 percent is also seen as a strong possibility at the June meeting.
Mari Iwashita, executive rates strategist at Nomura Securities, said a combination of a taper pause and rate hike would be complementary: the former would ease upward yield pressure, while the latter would signal the BOJ is not falling behind on inflation.
Former BOJ official Nobuyasu Atago told Reuters he sees no reason for the BOJ to keep tapering next fiscal year, given the political headwinds.
If the 10-year yield breaches 3 percent, the threshold the finance ministry used in compiling its fiscal 2026 budget, debt servicing costs would rise and crowd out other spending, Reuters noted.
The BOJ's holdings currently sit at around 500tn yen, though natural bond maturities have already reduced that from a late-2023 peak by approximately 20 percent.
On the fiscal side, Takaichi's ruling Liberal Democratic Party has proposed issuing "bridging bonds" to fund flagship growth and economic security programmes, Reuters reported.
The instruments cover temporary funding needs and carry specific repayment guarantees, allowing the government to argue fiscal discipline even as spending rises.
Because they are classed as temporary, bridging bonds would be excluded from Japan's standard fiscal measurements including its debt-to-GDP ratio.
"Markets may take the idea as negative for Japan's fiscal discipline as the government may ramp up spending without solidifying the means to fund it," said Keisuke Tsuruta, senior bond strategist at Mitsubishi UFJ Morgan Stanley Securities, according to Reuters.
The administration faces further fiscal pressure: a temporary freeze of an 8 percent food levy under consideration would cost roughly 10tn yen, and defence spending is expected to rise.
At twice the size of its economy, Japan holds the largest public debt among major economies.
