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Bank of Japan's dilemma: rising inflation, falling yen create pressure to end zero rate policy. But a sizable rate rise would boost its debt-servicing costs, possibly triggering a cycle of more borrowing at higher rates. @TokyoWoods @megumifujikawa report https://t.co/m7lO7bVhY9

— Greg Ip (@greg_ip) December 18, 2022

I am by no means an expert on the Japanese economy but for a decade or so some big-name investors – like Hayman Capital’s Kyle Bass who made his name forecasting the 2008 crash – have been awaiting a day of reckoning in Japan. That’s because Japan has been running huge deficits enabled by the Bank of Japan (BOJ) buying huge amounts of Japanese Government Bonds (JGBs) for years – or perhaps even longer.

According to an article in Monday’s WSJ by Yuka Hayashi and Megumi Fujikawa Japan’s debt to GDP level had risen to 263% by the end of 2021 – the highest in the developed world. However, Japan’s debt servicing costs have stayed manageable because of extremely low-interest rates (“Time Might Run Out On Japan’s Low-Rate Policy”).

Overnight Monday the BOJ surprised almost everyone when it raised the cap on 10-year JGBs from 0.25% to 0.5% – apparently in response to rising inflation. Yields on the 10-year JGB surged.

The problem is that rising interest rates threaten Japan’s debt servicing costs on its massive debt. So Japan seems to be caught between a rock and a hard place: the BOJ needs to tighten policy to deal with rising inflation but doing so would put enormous strain on the government’s budget.

Like I said at the beginning, I am no Japan expert. But having heard all the doomsday prophecies about Japan for so long combined with the BOJ’s move last night my sense is that this may be the beginning of something big.

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