Japan Economic & Financial Weekly

Long-term and super-long-term JGB yield scenario for May

Long-term and super-long-term JGB yield scenario for May

In May, the JGB market will focus on the policy responses of the government and the Bank of Japan toward inflation triggered by high crude oil prices (i.e., the policy mix). However, as outlined below, a strong policy response aimed at containing inflation appears unlikely, keeping upward pressure on the 10-year sector. As a result, the 10-year yield is likely to edge higher or remain elevated, as the market shies away from uncertainty surrounding the inflation outlook.

As this report was being written, there had been no notable progress in negotiations aimed at ending the fighting between the US and Iran, and the defacto blockade of the Strait of Hormuz was still in effect. Prime Minister SanaeTakaichi, at an April 30 meeting of cabinet ministers to discuss the Middle Eastsituation, said that Japan would have all the crude oil it needed beyond the end of2026 and that necessary supplies of naphtha would also be secured beyond year-end via alternative (non-Middle East) procurement routes. The risk of imminentlarge-scale supply chain disruptions in Japan is therefore small. On the other hand,moves to pass on higher costs to customers are likely to gain momentum goingforward. In a May 2026 survey of price hikes at 195 major food manufacturersreleased on April 30, Teikoku Databank said that prices would be raised for only 70food and beverage items in the month of May but noted that price hikes due to theworsening situation in the Middle East have begun to appear even in food andbeverages. It argued that a widespread resurgence of price hikes for food and beverages is likely as early as this summer or around autumn at the latest.

Of particular interest is the fiscal and monetary policy response to these developments. Prime Minister Takaichi told the Upper House Budget Committee on April 27 that “at this point in time, I do not think a supplementary budget will be necessary (translated by MUMSS),” but Reuters reported on April 30 that the government is considering resuming its subsidies for electricity and gas charges ona limited-term basis this summer. For the time being, these subsidies are expectedto be funded using the roughly JPY1 trillion in reserve funds in the FY26 budget,but we think those funds would be exhausted if the current gasoline subsidies areleft in place, making it necessary to compile a supplementary budget. Additionally,the ruling coalition continues to discuss a two-year consumption tax exemption forfood products (one of its campaign pledges in the last general election) at thegovernment’s Social Security Reform Council. At a working-level meeting on April24, the Ministry of Economy, Trade and Industry explained that major system vendors could make the necessary modifications within six months or so if the consumption tax on food products were reduced to 1% instead of being eliminated entirely. As yet there have been no voices within the government or ruling coalition calling for a postponement of the promised tax cut. Ms. Takaichi may well try to implement it, but we have not heard any discussions regarding how it might be funded. The prime minister is likely to keep “responsible and proactive fiscal policy" as a pillar of “Sanaenomics” in the government’s Basic Policy on Economic and Fiscal Management and Reform to be compiled in June. Concerns over expansionary fiscal policy, including a mechanism for compiling multi-year budgets, are likely to linger among JGB market participants as summer approaches.

The Bank of Japan decided to keep the policy rate at 0.75% at its April 27-28Monetary Policy Meeting. However, three Policy Board members (Hajime Takata, Naoki Tamura, and Junko Nakagawa) opposed the decision and argued that rates should be raised to 1.00%. This was the first time since Governor Kazuo Ueda took office that a decision was opposed by three Board members. The dissenting vote by Ms. Nakagawa, who had previously always voted with the governor and his two deputies, came as a particular surprise. The BoJ also sounded a stronger warning than expected on upside risks to prices in the Outlook Report. It explicitly stated that “it is necessary to pay due attention, in particular, to keep the risk of inflation significantly deviating upward from materializing and thereby exerting an adverse impact on the economy afterward, given factors such as underlying CPI inflation approaching 2% and firms’ behavior shifting more toward raising wages and prices.” In the sense that the Bank firmly addressed the upside risks to prices, wethink the meeting outcome can be described as a hawkish decision to leave rateson hold.

That said, the three Policy Board executives (Governor Ueda and his two deputies)did not submit a rate-hike proposal. At the press conference following the meeting,one reporter asked Governor Ueda, “How much risk do you see of pricesovershooting more than expected in the one and a half months between now andthe June meeting?” The Governor responded, “I think that, depending oncircumstances, the data through June may not clearly show substantial upwardpressure on consumer prices.” By using the language “depending oncircumstances” and “may not,” it is clear that he anticipates some increase inprices. Governor Ueda said the Bank stood pat this time because “the certainty ofour baseline outlook has declined considerably (the press conference Q&A wastranslated by MUMSS).” All would be well if that “certainty” has returned at the nextMPM on June 15-16, but if it has not, will the BoJ still be able to proceed with arate hike on the grounds of heightened upside risks to prices (the “secondperspective” of monetary policy conduct)? This needs to be carefully monitoredinasmuch as heightened concerns over future inflation could push the 10-year JGByield higher if market participants begin to doubt the feasibility of a rate hike (weanticipate a rate hike at the June MPM).