Japan may experience further declines in the yen and persistent rises in government bond yields due to market concerns over the country’s expansionary fiscal policy, according to former Bank of Japan (BOJ) board member Seiji Adachi.

Weak Yen Despite Interest Rate Hike

The yen has weakened even after the BOJ raised interest rates to a 30-year high of 0.75% last Friday. Markets interpreted Governor Kazuo Ueda’s post-meeting remarks as signaling a cautious approach, with no immediate rush for further rate hikes.

Adachi noted that the yen’s weakness is driven more by doubts about Japan’s fiscal stability than by BOJ policy:

“The yen is weakening despite narrowing Japan-U.S. interest rate differentials, which means it has little to do with BOJ policy. Investors are demanding a higher premium for Japan’s fiscal risk.”

Government Bond Yields Surge

Rising concerns about Japan’s public debt have contributed to Japanese government bond (JGB) yields hitting a 27-year high of 2.1%. The benchmark 10-year yield reflects both prospects of further BOJ rate hikes and expectations of large debt issuance to fund government spending.

BOJ Policy Outlook

Adachi forecasts that the BOJ could raise interest rates up to 1.5%, with the next increase expected around July 2026. However, higher rates would increase the funding costs of Japan’s enormous public debt, especially given Prime Minister Sanae Takaichi’s expansionary fiscal policies.

Fiscal Policy and Budget Outlook

Next fiscal year’s budget, the first under Takaichi, is expected to exceed 122 trillion yen ($781 billion), breaking previous records. This includes bond issuance surpassing last year’s 28.6 trillion yen, alongside a 21.3-trillion-yen stimulus package to support households facing rising living costs, as reported by the Nikkei newspaper.

Adachi warned that if the bond market selloff persists, the BOJ might be forced to review its bond tapering plans or devise mechanisms to support smaller banks affected by losses on their bond holdings.

Risks to Japan’s Economy

Adachi emphasized that rising bond yields represent the biggest economic risk for Japan in 2026, saying:

“It’s hard to erase market doubts over Japan’s finances after Takaichi branded her policies as proactive fiscal policy. Rising bond yields will be the biggest risk to Japan’s economy next year.”