3% Life-or-Death Line for Japanese Bonds! Former BOJ Official Warns: Fiscal Expansion May Force Central Bank to Buy Bonds

Sanae Takaichi's blueprint for fiscal expansion is directly colliding with the Bank of Japan's tightening monetary policy. Former BOJ official Seiji Adachi issued a clear warning: If the 10-year Japanese government bond yield breaks 3%, the government may pressure the central bank to ramp up bond purchases, which could trap the BOJ in a “fiscal dominance” dilemma during its rate hike cycle.

On July 15, according to Reuters, Seiji Adachi said in an interview that 3% is the “life-or-death line” in Takaichi’s fiscal logic—if crossed, the core premise of “economic growth will outpace interest rates, so debt is not a concern” will be subjected to market scrutiny. On Thursday, the 10-year Japanese government bond yield was at 2.675%, last week it briefly hit a 30-year high of 2.865%. The market’s contest around the key 3% threshold has just begun.

Analysts pointed out that the key to this policy contest is: Can the Bank of Japan withstand political pressure while continuing to raise rates? If forced to buy bonds, its process of monetary policy normalization will suffer a substantial setback.

3%: The Life-or-death Line of Takaichi's Fiscal Logic

The draft of Sanae Takaichi's economic blueprint has recently sparked intense market doubts about Japan’s fiscal discipline, directly driving the surge in 10-year Japanese government bond yields. Seiji Adachi’s analysis gets to the heart of the issue:

The Takaichi administration’s premise for increased spending is that nominal economic growth must remain higher than long-term interest rates over the long term, allowing Japan to manage its massive debt burden without compromising fiscal health.

But with inflation holding around 2% and real economic growth barely hovering at 1% at best, this premise is facing a severe test. “If the 10-year yield rises above 3%, it will trigger doubts about Japan’s fiscal sustainability,” Seiji Adachi said. He revealed that Japan’s government likely regards the 3% to 3.5% yield range as a critical line of defense that must be held.

Seiji Adachi emphasized that what is pushing up yields now is not the current debt-to-GDP ratio, but deep concerns in the market about Japan’s future ability to maintain fiscal discipline—“The proportion of debt to GDP in Japan may actually be declining, but the driver behind rising yields is not the current fiscal situation; it is concern over whether Japan can protect fiscal discipline in the future.”

The Shadow of “Fiscal Dominance” Over the Tightening Process

The Bank of Japan is on a difficult road toward policy normalization. In June, the central bank raised its benchmark rate by 25 basis points to 1%, the highest since 1995, by a 7-1 vote. Meanwhile, to shrink the asset balance sheet inflated by a decade of massive monetary stimulus, the BOJ has been slowing government bond purchases since 2024 and decided to keep monthly bond purchases at about 2 trillion yen from April 2027.

However, expectations for fiscal expansion and monetary tightening are inherently in conflict. Rate hikes raise government borrowing costs, while Takaichi's fiscal plan needs a relatively easy financing environment. Seiji Adachi warned:

“Depending on how quickly yields climb, the government may exert political pressure on the Bank of Japan, urging it to increase bond purchases to suppress yields.”

Notably, after removing yield curve control (YCC), the Bank of Japan no longer regards bond buying as a monetary policy tool. But any emergency purchases would complicate efforts to unwind the legacy of former Governor Haruhiko Kuroda’s aggressive stimulus. Seiji Adachi also noted that the government is unlikely to publicly advocate delaying rate hikes, as that could spark panic over runaway inflation, pushing yields even higher.

Rate Hike Path Divergence: The Real Test Comes After 1.25%

After multiple hikes, the market is significantly divided over the BOJ’s next steps.

Reuters reported that Seiji Adachi expects, as inflation may gradually rise in the coming months, the BOJ could raise short-term policy rates to 1.25% sometime between October this year and January next year. Surveys show most analysts also expect rates to reach 1.25% by year-end.

Seiji Adachi pointed out that 1.25% will bring the BOJ's policy rate to a neutral level for the economy. “Once rates reach 1.25%, the BOJ’s rate decisions will become inflation-risk-driven. The purpose of rate hikes will shift from adjusting monetary support to fighting inflation,” he said.

This means the BOJ’s policy game will unfold in two stages: The first stage is from 1% to 1.25%, mainly testing the central bank’s policy independence under fiscal pressure; the second stage is above 1.25%—depending on Middle East developments and oil prices, Seiji Adachi believes the BOJ might push rates further to 1.5% or even 1.75% sometime next year.

Reuters quoted sources saying the BOJ will keep rates unchanged this month, but will continue to focus on inflation risk overshooting—yen weakness drives up costs, and strong AI demand is partly offsetting the impact of falling oil prices. The BOJ's balancing act between policy autonomy and fiscal reality is far from over.

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