Japanese government bonds concluded 2025 with their most dramatic annual yield surge in three decades, as the final trading day saw continued pressure on bond prices amid mounting concerns over fiscal policy and monetary tightening.

Record-Breaking Yield Performance

The benchmark 10-year Japanese government bond yield climbed 2 basis points to 2.075% on Tuesday, approaching the 2.1% level reached on December 22 that marked the highest point since February 1999. The year's performance was particularly striking, with yields surging nearly one full percentage point throughout 2025, representing the steepest annual increase since 1994.

Central Bank Policy Transformation

The Bank of Japan implemented significant policy changes that fundamentally altered the bond market landscape. The central bank raised its key policy rate to 0.75% from 0.50% earlier this month, marking a 30-year high for Japanese interest rates. This monetary tightening represented a dramatic shift from the ultra-accommodative policies that had characterized Japanese monetary policy for decades.

The two-year yield, which demonstrates the highest sensitivity to central bank policy rates, rose 1 basis point to 1.165%, reflecting market expectations for continued policy normalization. A summary of opinions from the recent Bank of Japan meeting, released on Monday, revealed that many board members recognized the necessity for further rate increases to address persistent inflation pressures.

Fiscal Stimulus Concerns Drive Volatility

Long-term yields experienced particularly sharp increases since early November, hitting successive record highs as markets grappled with concerns over Prime Minister Sanae Takaichi's expansive spending plans. The government's embrace of a growth strategy based on massive fiscal stimulus created uncertainty about Japan's long-term fiscal sustainability, contributing to the bond market's volatile performance throughout the year.

The combination of reduced central bank bond purchases and entrenched inflation created a challenging environment for Japanese government bonds. The Bank of Japan's decision to scale back its extensive bond buying program removed a key source of demand that had previously supported bond prices and suppressed yields.

Future Policy Outlook

Market analysts anticipate continued monetary policy tightening, with Mizuho Securities senior market economist Yusuke Matsuo identifying July as the most likely timing for the next rate hike. However, the pace of policy normalization could accelerate depending on currency market developments, particularly if the yen continues weakening against the dollar.

Key factors influencing future policy decisions include:

• Yen exchange rate stability
• Inflation trajectory and persistence
• Fiscal policy implementation effects
• Global economic conditions

Matsuo emphasized that currency defense could become a priority for policymakers, potentially leading to an acceleration of the planned rate hike schedule. This dynamic adds an additional layer of complexity to the Bank of Japan's monetary policy considerations as it balances domestic economic conditions with external currency pressures.

Japan's cabinet approved a record budget of 122.3 trillion yen ($784.63 billion) for the fiscal year beginning April, marking a significant increase in government spending while attempting to maintain fiscal discipline through controlled debt issuance.

Budget Overview and Fiscal Metrics

The approved budget represents a substantial increase from the current year's initial allocation, with the government balancing increased spending against debt management concerns.

Revenue and Expenditure Dynamics

The budget structure reflects Japan's efforts to fund increased spending through higher tax revenues while managing debt-servicing obligations. Tax revenues are projected to reach a record ¥83.7 trillion, representing a 7.6% increase that will partially offset rising expenditures.

Debt-servicing costs present a significant challenge, with payments for interest and debt redemption expected to jump 10.8% to ¥31.3 trillion. The government has set the assumed interest rate at 3.0%, marking the highest level in 29 years as the Bank of Japan transitions away from ultra-loose monetary policy.

Fiscal Policy Challenges

Japan faces unique fiscal constraints given its debt burden, which exceeds twice the size of its economy—the highest ratio among developed nations. This elevated debt level creates heightened sensitivity to rising borrowing costs and complicates aggressive fiscal stimulus measures.

The administration plans to modify Japan's fiscal consolidation approach by moving away from the annual primary budget balance as the primary goal, instead establishing multi-year targets to enable more flexible spending policies.

Economic Context and Market Considerations

The budget approval comes amid challenging economic conditions, including rising government bond yields and yen weakness. These factors have prompted increased efforts to reassure investors about responsible fiscal management and controlled debt issuance practices.

The government's approach demonstrates an attempt to balance proactive fiscal policy with debt sustainability concerns, limiting new bond issuance growth while accommodating necessary increases in social welfare and defense spending.