Japan’s central bank is confronting a delicate balancing act as soaring government bond yields threaten to derail its policy normalization efforts.

The Bank of Japan now faces a difficult choice: continue raising interest rates and risk even higher yields that could further slow an already fragile economy, or hold rates—or even cut—to support growth, which could intensify inflationary pressures.

Over the past month, Japanese government bonds have reached new highs. On Thursday, the benchmark 10-year JGB yield climbed to 1.917 percent, marking its strongest level since 2007. The 20-year bond hit 2.936 percent, unseen since 1999, while the 30-year reached a record 3.436 percent, according to LSEG data.

Japan ended its yield curve control program in March 2024, which capped 10-year bond yields at around 1 percent, as part of broader policy normalization that also concluded the nation’s long-standing negative interest rate regime.

With inflation above the Bank of Japan’s 2 percent target for 43 consecutive months, the risk of yields surging even higher poses a major challenge. Anindya Banerjee, head of currency and commodities at Kotak Securities, told CNBC’s “Inside India” that a return to quantitative easing and yield curve control could weaken the yen and worsen imported inflation.

Rising bond yields also increase borrowing costs, putting additional pressure on Japan’s fiscal situation. The country carries the world’s highest debt-to-GDP ratio at nearly 230 percent, according to the International Monetary Fund. The government plans its largest stimulus package since the pandemic to ease living costs and support the economy, raising concerns about the sustainability of its debt.

Magdalene Teo, head of fixed income research for Asia at Julius Baer, noted that the new 11.7 trillion yen debt issuance under Prime Minister Sanae Takaichi’s supplementary budget is 1.7 times larger than the previous year’s issuance, underscoring the tension between economic stimulus and fiscal prudence.

Globally, analysts remain cautious. Rising Japanese yields narrow the rate gap with the U.S., reducing the attractiveness of yen-funded carry trades, though experts say a repeat of the 2024 market turmoil is unlikely. Masahiko Loo, senior fixed income strategist at State Street Investment Management, said structural flows from pensions, life insurance, and NISA programs anchor foreign holdings, limiting large-scale repatriation.

HSBC’s Justin Heng added that Japanese investors have continued purchasing foreign bonds, with 11.7 trillion yen invested overseas from January to October 2025, up from 4.2 trillion yen in 2024. He noted that declining hedging costs, supported by further Federal Reserve rate cuts, are expected to encourage more foreign bond investment.

As Japan navigates rising yields, inflation pressures, and fiscal constraints, policymakers face mounting challenges in balancing economic growth with financial stability.

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