Yields on Japanese government bonds soar to multi-decade highs, BOJ's quantitative tightening may end earlier than expected.

Japan’s government bond yields have recently surged to their highest levels in decades, intensifying turbulence in the bond market and forcing the Bank of Japan (BOJ) to re-examine its quantitative tightening path.

Reuters, citing two sources familiar with the matter, reported that the BOJ will convene a policy meeting from June 15 to 16, during which it will assess the current bond reduction plan and formulate a new scheme for fiscal year 2027. The report, quoting insiders, indicates that amidst continued disruptions in the bond market caused by Middle East tensions, pausing balance sheet reduction has become an increasingly favored option. "The market remains volatile, there’s no need to rush things,"

The yield on 10-year Japanese government bonds (JGBs) hit 2.8% last week, a 30-year high and approaching the 3% warning line set by the Ministry of Finance for the fiscal 2026 budget. If yields breach this threshold, it will significantly elevate debt-servicing costs, further straining fiscal space, and directly constrain Prime Minister Sanae Takaichi’s policy agenda for tax cuts and expanded spending.

This discussion comes amid multiple pressures for the BOJ—bond market volatility, intensifying political pressure, and difficult trade-offs about whether to raise interest rates in June as well. Market participants and former BOJ officials generally see pausing balance sheet reduction as reasonable, but it also raises doubts over the BOJ’s ability to stick to its monetary normalization path.

Yield Surge Triggers Fiscal Alarm

Growing concerns about Japan’s fiscal situation and rising inflation pressures are jointly driving rapid increases in bond yields. The 10-year JGB yield last week reached a 30-year high of 2.8%, just a step away from the 3% reference set in the Ministry of Finance’s 2026 budget.

Former BOJ official Nobuyasu Atago said, "We are seeing yields rise quite rapidly, making it difficult for investors to buy bonds—the Ministry of Finance may also be starting to worry." He added, "Given political resistance, I don’t think the BOJ has reason to continue balance sheet reduction in the coming fiscal year."

Insiders also pointed out, "The last thing the authorities want to see is rising government bond yields." If yields cross 3%, Japan’s government debt-servicing costs will inflate further, squeezing already limited fiscal space.

Balance Sheet Reduction Plan Faces Pause Pressure

The BOJ launched its quantitative tightening plan in 2024 as a crucial step by Governor Kazuo Ueda to unwind a decade of ultra-loose stimulus policy. Under this plan, the central bank is gradually reducing its government bond purchases, currently cutting monthly purchases by ¥20 billion each quarter. The BOJ’s current JGB holdings are around ¥500 trillion.

According to two sources familiar with related discussions, the BOJ has not yet reached consensus on a final plan, but pausing balance sheet reduction is becoming a favored option. Reuters is known in markets for conveying signals from within the BOJ, and this report is widely viewed as a credible policy probe.

In a BOJ survey earlier this month, some investors explicitly called for a pause in the bond reduction plan, highlighting the practical challenges the central bank faces in reducing its massive bond holdings. Notably, even if the plan is paused, maturing JGBs will still gradually roll off, and the BOJ’s balance sheet has already shrunk by about 20% from its end-2023 peak—a process set to continue.

Political Pressure Strengthens Policy Resistance

Political factors are also significant. After taking office, Sanae Takaichi openly promised to issue more government bonds to implement tax cuts and expand fiscal expenditure, increasing resistance to the BOJ’s balance sheet reduction plan. This policy stance, in the world’s most indebted economy, has sparked concerns among investors about fiscal sustainability and has become a major driver for rising yields.

Akira Otani, former BOJ executive now at Goldman Sachs Japan, said, "When inflation risks from Middle East conflicts and aggressive government fiscal policies exert upward pressure on bond yields simultaneously, continuing balance sheet reduction may spur political friction due to higher yields."

Insiders also candidly noted that political considerations are an unavoidable backdrop for BOJ decisions, and the rapid rise in yields has further narrowed room for maneuver.

Policy Mix of Rate Hikes and Balance Sheet Reduction

Aside from pausing balance sheet reduction, the possibility of the BOJ raising its short-term rate from 0.75% to 1% at the June meeting is also seen as quite likely in the market. Mari Iwashita, head of rates strategy at Nomura Securities, said, "A combination of pausing balance sheet reduction and raising rates is an optimal policy mix"—the former helps relieve upward yield pressure, while the latter reassures the public that the BOJ is not lagging in addressing inflation risks.

She also predicts that the BOJ will pause balance sheet reduction in fiscal year 2027 and noted: "Given how unstable the bond market is, it’s logical for the BOJ to take a prudent stance and avoid unnecessary volatility."

The BOJ has consistently emphasized its balance sheet reduction plan is independent and not directly tied to its monetary policy stance. However, if the central bank pauses reduction while raising rates, this distinction will become subtler and markets may find it harder to interpret the consistency of its policy framework.

Japan’s predicament is not unique. Years of large-scale asset purchases have greatly expanded major central banks' balance sheets, and now most face resistance to reducing holdings. In the U.S., analysts doubt whether new Fed Chair Kevin Warsh can advance his agenda for balance sheet reduction, as U.S. Treasuries have lost some market appeal.

The next clear signal from the BOJ will come next week—when the central bank publishes the minutes of its meetings with bond market participants held on May 21–22, and the market will look for clues about latest adjustments to balance sheet reduction plans.

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