Rate Hikes Strain Public Finances, Cuts Risk Inflation as Central Banks Face Dilemma

Japan Bond Yields Jump After Government Appears to Lean Against Rate Increases

Treasury, Fed Clash in US Over Long-Term Yields

Japan’s 10-year government bond yield surged to 2.9% on June 30, the highest level in 30 years. The jump came just after the government of Prime Minister Sanae Takaichi released its annual basic policy guidelines on economic and fiscal management, known as the Honebuto policy. A line stating that “appropriate conduct of monetary policy by the Bank of Japan is also extremely important” to achieve a “strong economy” sparked the selloff.

Japan’s consumer prices stayed above the central bank’s 2% target for 45 consecutive months through December last year. They have remained at 1.8% to 1.9% this year. The Bank of Japan raised its policy rate to 1.0% in June, but that has not been enough to curb inflation. Investors took the government’s wording as an encroachment on BOJ independence and bond vigilantes responded with a warning. The government later revised the language, but yields kept rising and the yen fell sharply.

The episode underscores the BOJ’s dilemma. Higher rates worsen the government’s fiscal position. Rising bond yields lift interest costs, and issuing more debt to cover them risks deepening the cycle of debt accumulation. If the BOJ delays further rate increases because of the fiscal burden, the weak yen and higher import prices could persist. The Takaichi government’s expansionary fiscal policy is also adding to the strain on monetary policy.

The Federal Reserve faces a similar predicament. With long-term Treasury yields climbing, the Treasury Department and the Fed are increasingly at odds over how to respond. Treasury Secretary Scott Bessent has proposed expanding bond buybacks. Talk of using the Treasury General Account, the federal government’s cash account, to fund those purchases has fueled criticism that the Treasury is effectively embarking on quantitative easing. For Fed Chair Kevin Warsh, who has consistently opposed growth in the money supply and an expanded Fed balance sheet, the Treasury’s move is difficult to accept.

If Warsh, whom markets suspect is aligned with President Donald Trump, moves in lockstep with the Treasury, questions over central-bank independence could intensify. If he tries to rein in the Treasury instead, he risks a direct clash with the administration.

In South Korea, the Bank of Korea raised its benchmark interest rate on August 28 for a second straight month. That has intensified debate over whether policy is out of step with the government, which is pushing to draft a record budget for next year of more than 800 trillion won ($578.8 billion).

Choi Man-su, Tokyo correspondent, Korea Economic Daily, bebop@hankyung.com

Shim Seong-mi, reporter, Korea Economic Daily, smshim@hankyung.com