BoJ holds rates as Japan's bond crisis threatens global markets

The Bank of Japan held its policy interest rate steady at 0.75% on Friday, resisting pressure to raise borrowing costs despite a historic collapse in Japanese bond markets that has begun rippling through global financial systems. The decision to pause came after a tumultuous week that exposed deep fault lines between Japan's political ambitions and economic reality—a collision that has left investors worldwide watching nervously to see what happens next.

The trigger was unmistakable. On Monday, Prime Minister Sanae Takaichi announced snap elections for February 8 and pledged to suspend Japan's 8% consumption tax on food for two years. The move was designed to appeal to voters struggling with inflation, but it landed like a bomb. The annual revenue from that tax alone is roughly 5 trillion yen, or about 31.5 billion euros. Markets already anxious about Japan's debt-to-GDP ratio—hovering near 240%, the highest in the developed world—saw the unfunded tax cut as fiscal recklessness. Takaichi also unveiled a spending package of 21.5 trillion yen, or about 115 billion euros, further stoking concerns. By Tuesday, Japanese bonds experienced their worst day in years. The yield on the 40-year note broke through 4% for the first time since 2007. The 30-year bond yield jumped nearly 30 basis points to roughly 3.9%, a record high. The 10-year yield, still elevated at around 2.25%, marked its highest level since 1999.

Takaichi took office in October 2025 as Japan's first female prime minister, stepping in after her predecessor Shigeru Ishiba resigned following political setbacks. Her party, the ruling Liberal Democratic Party, had lost its majority in the upper house when its longtime coalition partner, Komeito, withdrew over a political funds scandal. The LDP formed a new coalition with the centre-right Japan Innovation Party and, under Takaichi's leadership, managed to hold a slim majority while building strong approval ratings, particularly among younger voters. The snap election was meant to capitalize on that popularity and secure a fresh mandate. "I am putting my position as prime minister on the line," Takaichi said during her announcement. "I want the people themselves to decide whether they are willing to entrust Takaichi Sanae with the task of running our nation." Her opponents, having merged at the start of the year into the Centrist Reform Alliance, are trying to exploit voter anger over living costs. The food tax cut was supposed to be Takaichi's trump card—a direct benefit to households. Instead, it has driven up mortgage rates and corporate borrowing costs through the bond market turmoil.

The central bank's decision to hold rates reflects a delicate calculation. Just last month, the BoJ had raised its key rate to 0.75%, a 30-year high, as part of an effort to normalize policy after decades of near-zero or negative rates. Pausing now allows the economy time to absorb that December increase. The bank also upgraded its growth forecasts, raising its expectation for 2025 to 0.9% and for the current fiscal year to 1%, both up from a previous forecast of 0.7%. Yet the rate hold does not address the deeper fear that seized global markets: concerns about Japan's ability to service its massive debt load, especially as the BoJ winds down its decades-long bond-buying program that has kept yields artificially low.

The comparison to Liz Truss's disastrous "mini-budget" in the UK in 2022—a package of unfunded tax cuts that triggered market chaos and forced her resignation within weeks—has circulated uncomfortably in financial circles. Takaichi's ideology draws from Abenomics, the loose fiscal and monetary policy championed by her mentor, the late Shinzo Abe, which assumes that inflationary pressure can be managed. But Japan's consumer price index has already hovered above the central bank's 2% target for four years, suggesting inflation may already be taking hold.

The bond market panic subsided somewhat by Thursday as government officials, including Chief Cabinet Secretary Minoru Kihara, sought to calm investors by insisting the administration was "keeping a close eye" on bond movements. But the underlying tension remains unresolved.

What happens in Tokyo now matters far beyond Japan's borders. For years, investors worldwide have profited from the "yen carry trade"—borrowing money in Japanese yen at very low interest rates and investing it in higher-yielding assets denominated in currencies like the US dollar. The profit comes from the spread between what they pay to borrow and what they earn on the investment. But if the yen strengthens or the BoJ raises rates further, the cost of repaying those loans spikes, forcing investors to panic-sell assets to cover their debts. That's exactly what happened this week. The Japanese bond rout triggered violent repricing across global markets, pushing US Treasury yields higher. Japan holds over 1 trillion dollars in US Treasuries, making it the largest foreign holder of American debt. At the World Economic Forum in Davos on Wednesday, US Treasury Secretary Scott Bessent acknowledged the spillover: "It's very difficult to disaggregate the market reaction from what's going on endogenously in Japan." He emphasized that the primary pressure on US markets stems from the fiscal shift unfolding in Tokyo, not other geopolitical distractions. If Takaichi's spending-heavy policies continue to fuel inflation fears, the BoJ may feel compelled to raise rates further, unwinding the yen carry trade more violently and sending shockwaves through asset prices worldwide. The election on February 8 will be watched closely not just in Japan, but in trading rooms and central banks across the globe.