Deutsche Bank: Japan May Shift Policy Focus from Supporting Yen to Controlling Government Bond Yields to Support Economic Growth Plans

According to Zhihui Finance APP, Deutsche Bank stated that in order to achieve the Japanese government's ambitious economic growth targets, Japan may need to shift its policy focus from supporting the yen to controlling government bond yields in the future, so as to reduce financing costs and ensure fiscal sustainability.

At the end of last month, Japanese Prime Minister Sanae Takaichi announced an economic growth plan totaling about $2.3 trillion. Deutsche Bank strategist Mallika Sachdeva pointed out in the latest report that this plan means Japan is at a critical juncture of major transformation in fiscal and industrial policies, with the government needing to maintain fiscal sustainability while expanding fiscal spending. According to the growth plan, the Japanese government hopes to activate domestic savings and encourage large institutional investors to increase allocations to domestic assets, providing funding for large-scale fiscal expenditure. At the same time, Japan must also ensure that nominal economic growth continues to outpace financing costs to maintain the sustainability of its debt burden.

Sachdeva believes that to achieve the above two goals, the Japanese government may need to take measures to suppress government bond yields and control overall financing costs.

This means Japan’s policy focus may change. For some time, both the Japanese government and the Bank of Japan have endeavored to contain the yen’s depreciation, including multiple large-scale foreign exchange interventions, but with limited effectiveness. This week, the yen fell to its lowest level in about 40 years, before rebounding somewhat on media reports that Bank of Japan officials are willing to hike rates faster than the market expects.

Sachdeva stated that if strengthening fiscal capacity becomes the top policy priority, Japan's future policy focus may shift from foreign exchange management to yield management, that is, from concentrating on the USD/JPY exchange rate to controlling the yield on 10-year government bonds and overall borrowing costs.

In fact, Japan implemented a Yield Curve Control (YCC) policy from 2016 to 2024 to suppress financing costs. Other countries such as the United States have adopted similar policies in history; for example, during World War II, the U.S. financed the war by controlling government bond yields.

Deutsche Bank pointed out that Japan is not the only developed economy facing high debt pressure and hoping to revive growth, but Japan has significantly less fiscal space than other major economies, as its government debt-to-GDP ratio has exceeded 200%.

Concerns over debt sustainability have already begun to be reflected in the bond market. Since the start of this year, Japan's long-term government bond yields have continued to rise, with the 30-year Japanese government bond yield hitting an all-time high.

Sachdeva expects that Japan is more likely to manage long-term yields in the future by influencing bond demand. One method is to require the $1.8 trillion Government Pension Investment Fund (GPIF) to increase its allocation to domestic assets to boost demand for Japanese government bonds.

Another possibility is that the Bank of Japan increases its support for the bond market, including resuming government bond purchases or continuing to maintain an accommodative monetary policy to help control yields.

However, she pointed out that if the Bank of Japan resumes bond purchases or maintains a loose policy, this could put pressure on the yen; conversely, if GPIF repatriates some of its overseas assets back to Japan, this could support the yen.

Sachdeva stated that in the future, as Japan suppresses government bond yield volatility, volatility in the foreign exchange market may further intensify.