Japan’s Long-Term Interest Rates Surge Amid Tax Cut Concerns

Economy## Interest Rate Increases Outpace Other Major Economies

Rises in Japan’s long-term interest rates have become prominent since the start of 2026, with a possible increase above 3% for the first time in 30 years. Prime Minister Takaichi Sanae’s announcement of a planned decrease in consumption tax on food from 8% to 1% beginning April 2027 has led to mounting concerns over filling the fiscal shortfall.

The long-term interest rate refers to the yields on 10-year Japanese government bonds. It is important because it serves as a benchmark for lending rates to businesses and mortgage rates. Government bonds are traded in financial markets, and their interest rates fluctuate in response to prevailing economic conditions and the government’s fiscal health.

Since the beginning of this year, the rise in long-term interest rates, reflecting a decline in government bond prices, has become particularly pronounced. According to data from the Ministry of Finance, the rate hit a 30-year high of 2.930% on August 17. Some market observers, such as Kumano Hideo, the chief economist at the ABC Economic Research Institute, believe the rate could reach the 3% range by August. The backdrop to the increase includes concerns about deteriorating fiscal health and rising inflation.

On July 30, Prime Minister Takaichi announced plans to cut the consumption tax and distribute cash payouts, which could lead to an annual funding shortfall of as much as ¥5 trillion. The prime minister offered little detail, stating only that the government would “review expenditures and revenue.” Meanwhile, market participants are “watching closely to see how far the government will be able to balance its books,” according to Ueno Tsuyoshi, senior economist at the NLI Research Institute.

Prime Minister Takaichi has also said that the tax rate will be restored to 8% two years later, in 2029. However, with an upper house election looming in 2028, a tax hike could be politically difficult. Ueno notes that “if the tax rate remains at 1%, securing additional sources of revenue will become a challenge,” raising doubts about Japan’s long-term fiscal health. If the government attempts to cover the shortfall by issuing large amounts of deficit-covering bonds, it will have to borrow increasingly large sums from investors, driving interest rates even higher.

Another factor behind the rise in long-term interest rates is inflation. Because inflation erodes purchasing power, interest rates must rise to keep government bonds attractive to buyers. At present, crude oil prices are volatile amid worsening conditions in the Middle East, while the accelerating slide of the yen has helped push the corporate goods price index (CGPI) up into the 5% to 7% range year on year since April. If companies pass these higher costs along to retail prices, consumer inflation is almost bound to accelerate heading into autumn.

The Bank of Japan’s slow pace of rate hikes, including its decision to leave its policy rate unchanged at its July policy meeting, has raised concerns that it may fail to rein in inflation, further adding upward pressure on long-term interest rates.

Long-term interest rates are now approaching the 3% range, which is a level not seen since 1996. Rates were on a downward trend throughout the 1990s, following the collapse of the bubble economy and the financial crisis. In the 2000s, Japan entered a deflationary spiral in which falling prices and deteriorating economic conditions reinforced one another, driving yields even lower.

Former BOJ Governor Kuroda Haruhiko, who was appointed to that position in 2013, embarked on “unprecedented monetary easing” in an effort to overcome deflation, purchasing massive quantities of government bonds in order to suppress long-term interest rates. As a result, long-term yields fell at one point into negative territory. His successor, Governor Ueda Kazuo, who took office in 2023, brought that period of monetary easing to an end. Long-term interest rates, which had been deliberately held at low levels, are now freer to move in line with actual market conditions.

Long-term interest rates are rising worldwide amid concerns about inflation, but Kumano notes that “Japan’s pace of increase is the fastest among G7 countries,” and suspects that this is because fiscal deterioration has become an additional driver.

Data Sources

(Translated from Japanese. Banner photo © Pixta.)