TOKYO – Yields on 10-year Japanese government bonds briefly topped 1 percent for the first time in a year on Thursday, unnerving some investors at a time when Japan's already overburdened government finances are vulnerable to rises in interest rates. Japanese shares fell sharply.
The spike in long-term debt comes despite the Bank of Japan's aggressive efforts to keep interest rates down. It followed overnight news that some officials of the U.S. Federal Reserve are willing to scale back the American central bank's stimulus effort as soon as June if the economy perks up.
The benchmark long-term bond yield later dropped back to about 0.9 percent, near its recent trading level.
Like the Fed, the BOJ is buying massive amounts of government bonds, seeking to keep interest rates low to encourage people and businesses to borrow and spend more — the main tenet of Prime Minister Shinzo Abe's "Abenomics" economic strategy.
The aim is to break out of a deflationary rut of sagging prices that has slowed investment and is thought to be discouraging consumers from spending. By raising expectations that rising prices mean their savings will go further now than later, the government hopes to get Japanese to step up spending, especially for big ticket items like cars and houses.
So far, the effort to "reflate" the economy has pushed share prices sharply higher: the benchmark Nikkei stock index has surged past 15,000, its highest level in over five years, though mid-afternoon Thursday it was down more than 6 percent because of the spike in bond yields and weak Chinese manufacturing figures. Meanwhile, the value of Japan's currency has fallen by 25 percent against the U.S. dollar since late last year. The yen was trading at about 102.6 to the dollar on Thursday after briefly passing 103 to the dollar.
If the central bank succeeds in reviving inflation, it will eventually have to raise interest rates to keep price rises in check. But low long-term rates are a priority for Japan because its government debt amounts to over twice the size of the economy. Higher rates would vastly increase the government's repayment burden as it continually sells new bonds to finance its deficits.
"Japan really has a long-term debt problem," said Franklin Allen, a professor at the Wharton School at the University of Pennsylvania. "If the long-term JGB (Japanese government bond) goes to 2.5 percent to 3 percent, there will be a financial stability problem."
The central bank has been grappling with unexpected swings in the market for Japanese government bonds since its new governor Haruhiko Kuroda announced in early April a drastic shift in policy aimed at doubling the amount of cash circulating in Japan's economy. The goal of the policy is to attain a 2 percent inflation target within two years.
"We've never seen this volatility in percentage terms on a daily basis that we're seeing today in the Japanese market," said Ken Courtis, a former Goldman Sachs vice chairman and investment banker.
The volatility raises questions over how much influence the BOJ wields over the market, despite soaking up about 70 percent of all new bond issuance.
Paying interest on the government debt already takes a quarter of government spending, he said.
"What will Japan do, he said, "when interest rates go up and debt servicing starts to swallow the entire budget?"
The level of Japan's debt is higher, relative to its economy, than even some of the crisis-stricken European countries. But because it is mostly owned by domestic investors, especially huge banks and insurance companies, the country's credit rating has remained steady.
But many Japanese financial institutions, especially regional banks and credit cooperatives, would be unable to keep such large holdings of government bonds if the value of those bonds drops too far, Allen said.
Japan's economy expanded at a faster-than-expected annual pace of 3.5 percent in the last quarter, a development many supporters view as a vindication of Abe's approach. The Bank of Japan ended a two-day policy meeting on Tuesday with no change in policy, saying the economy was "picking up," despite the lack of any change in price trends so far.
Critics contend that keeping interest rates artificially low to encourage borrowing merely encourages companies to waste money and avoid improving their efficiency and competitiveness.