By Tamiyuki Kihara and Leika Kihara
TOKYO, May 18 (Reuters) – Japan’s government is likely to issue fresh debt as part of funding for a planned extra budget to cushion the economic blow from the Middle East war, a government source with direct knowledge of the deliberations told Reuters on Monday.
Any additional debt issuance would further strain Japan’s already worsening finances and may accelerate rises in long-term interest rates.
Such concerns pushed the yield on the benchmark 10-year Japanese government bond (JGB) to 2.8% on Monday, its highest since October 1996, and the 30-year yield to a record top.
On Monday, Prime Minister Sanae Takaichi said she had told Finance Minister Satsuki Katayama last week to start work on compiling a supplementary budget, an aboutface from previous remarks ruling out the chance of an extra budget.
While the size of spending has yet to be worked out, the decision could cast doubt on the administration’s pledge to pursue a “responsible, proactive” fiscal policy.
“If the rise in yields starts to hit domestic stock prices and heightens the chance of a triple selling, that could increase criticism over … policy,” said Takeshi Minami, chief economist at Norinchukin Research Institute, referring to a combination of falling shares, bond prices and the yen.
“The administration will thus likely pay heed to market pressures in compiling the extra budget.”
In a proposal to the finance ministry, opposition party leader Yuichiro Tamaki called on Friday for an extra budget of about 3 trillion yen ($18.9 billion), which may serve as a benchmark for future debate on the size of spending.
The extra budget will focus on funding government subsidies to curb gasoline and utility bills, as surging oil prices caused by the Middle East conflict cloud the outlook for an economy heavily reliant on fuel imports from the region.
“When countries like Japan and Britain contemplate fiscal stimulus, there’s a tendency for that to trigger a triple selling of shares, currencies, and bonds because their economic growth is weak and inflationary risks are high,” said Daisuke Uno, chief strategist at Sumitomo Mitsui Banking.
The bond selloff would also complicate the BOJ’s decision on whether to raise its short-term policy rate to 1% from 0.75% at its next meeting in June.
At the June meeting, the BOJ will also review its existing bond taper plan and unveil a new plan for fiscal 2027 onward.
The war-induced spike in energy prices, coupled with rising import costs from the weak yen, pushed Japan’s wholesale inflation to a 3-year high of 4.9% in April, bolstering the case for the central bank to raise rates as soon as next month.
“If inflationary risks heighten, there’s a chance the BOJ could raise short-term rates to 1.5% by the March end of the current fiscal year,” said Mari Iwashita, executive rates strategist at Nomura Securities.
The 10-year yield could head towards 3%, Iwashita added.
($1=158.8900 yen)
(Reporting by Tamiyuki Kihara and Leika Kihara; Additional reporting by Mariko Sakaguchi, Yoshifumi Takemoto and Anton Bridge; Editing by Shri Navaratnam and Sam Holmes)
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