Long-Term Rates Near 3%, Squeezing Policy Room; Focus Turns to Full-Year Bond Issuance

Long-term interest rates are approaching 3%, and the yield on newly issued 10-year Japanese government bonds reached 2.945% on 18 August. This is expected to make it impossible for the fiscal 2027 budget process to ignore rising interest rates, as the balance between the Bank of Japan's monetary policy normalization and fiscal spending becomes increasingly uncertain. Reports put the budgeted interest rate at 3.0% and debt-service costs at ¥31.3 trillion, heightening concerns about fiscal expansion and increased government bond issuance.

There are calls for caution against assuming that government debt management policy is a panacea, while fiscal deficits and elevated long-term interest rates are coexisting in the United States as well. Forecasts from the IMF and developments at the U.S. Treasury point to market-adjustment measures, such as raising the ceiling on buybacks to ensure liquidity, but the view is that these measures will not directly resolve fiscal problems.

The quality of funding sources and the prioritization of investment have also emerged as issues. A proposed cut in the consumption tax rate on food and beverages is said to require funding of around ¥5 trillion annually, complicating estimates concerning funding for defense spending, free tuition and education, and growth investment. Unstable elements, including tax revenue exceeding projections and the return of unused fund balances, are also involved, and securing permanent funding sources could include reducing subsidies and reviewing the tax system.

Views are strengthening that full-year government bond issuance will become the de facto constraint on fiscal management. The Basic Policy 2026 indicates a policy of specifying the amount of issuance, and the end point will be important when considering full-year issuance for fiscal 2027. If issuance increases compared with past results, the market reaction will need to be monitored carefully.