"Sanaenomics," the policy platform that carried Prime Minister Sanae Takaichi to power in Japan, is coming under strain. Markets increasingly doubt that the Takaichi cabinet's aggressive fiscal stance amounts to anything more than spending without growth. The fiscal 2027 budget is expected to exceed a record 143 trillion yen (about 1,224 trillion won), yet the cabinet is pushing ahead with tax cuts and has scrapped ceilings on spending requests. Government bond yields have set successive highs as a result, and the yen has again weakened past 160 to the dollar.
Japan's 10-year government bond yield touched 3% on the 1st, its highest level since September 1996, the Nihon Keizai Shimbun reported. The move above 3% reflected market expectations that the Bank of Japan will raise its policy rate at its monetary policy meeting on the 17th and 18th.
What is shaking long-term yields at a deeper level, however, is the question of fiscal soundness. Budget requests submitted by central government ministries for fiscal 2027, disclosed by Japanese media the previous day, totaled a record roughly 143 trillion yen. The requests are preliminary spending estimates that each ministry compiles and submits to the Ministry of Finance. This is the first budget the Takaichi cabinet has drawn up in full, in its second year in office.
The cabinet decided not to cap ministry requests tied to growth or crisis management. It also allowed so-called item requests, which list programs without specifying the amounts needed.
A cut to the consumption tax on food is also set to take effect next spring. The resulting revenue loss is projected at roughly 4 trillion to 5 trillion yen a year, but Takaichi has offered only a vague plan, saying the government will "secure the funds by reviewing non-tax revenue and subsidies, without relying on deficit bond issuance." In an interview with the Yomiuri Shimbun on the 29th of last month, she also stressed again that the government would keep bond issuance near current levels, saying it had "held new bond issuance in the fiscal 2025 supplementary budget to around 40 trillion yen, below the previous year's level."
The cabinet is also promoting 370 trillion yen in combined public and private investment through 2040 across 17 strategic sectors, including artificial intelligence and semiconductors, adding to the fiscal burden. Real gross domestic product, meanwhile, grew at an annualized 1.1% in the second quarter, below both the previous quarter's 1.9% and market expectations of 2.0% — a sign that the fundamentals underpinning Japan's growth are weak.
The fiscal alarm has revived Japan's chronic problem of yen depreciation, and Washington has called for higher rates. The yen fell past 160 to the dollar in the afternoon, erasing the support it gained from joint U.S.-Japan intervention in the currency market on July 31. That has added urgency in the United States, which is already struggling with high long-term Treasury yields. If Japan sells U.S. Treasuries to secure ammunition for defending the yen, U.S. yields could climb further. Reluctant to intervene again, Washington sees an early rate increase by the Bank of Japan as the means to support the currency.
U.S. Treasury Secretary Scott Bessent held back-to-back meetings with Japanese Finance Minister Satsuki Katayama and Bank of Japan Governor Kazuo Ueda on the 31st of last month at a Group of 20 finance ministers' meeting in Asheville, North Carolina, NHK reported. Bessent said at the meetings that it was important to present the market with a clear path toward fiscal sustainability and rate increases, comments understood as effectively pressing for higher rates. In an interview with CNBC, he also said he trusted that the Japanese government and the Bank of Japan would take steps leading to a stronger yen.
