Bank of Japan Expected to Raise Interest Rates in June, Considers Pausing Debt Repayment Next Fiscal Year

The Bank of Japan is scheduled to hold a monetary policy meeting on June 15-16, and the market's attention to this meeting is unusually high. The market generally expects the Bank of Japan to raise the benchmark interest rate from 0.75% to 1%, with the probability of a rate hike rising to 73%. At the same time, the meeting will also assess the implementation of the current debt reduction plan through next March and formulate a new plan for fiscal 2027, which is becoming the real focus of market controversy.

Two informed sources revealed to the media that although no final conclusion has been reached within the Bank of Japan, against the backdrop of the continued disturbance of the bond market by the Iranian situation, the pause of debt reduction in fiscal 2027 has gradually become a mainstream tendency. One of them stated directly: "The market remains volatile, there is no need to rush into action." He also added that most market participants also tend to maintain the current bond purchase scale unchanged.

The bond market's pressure is the core driving factor. Last week, the 10-year Japanese government bond yield rose to 2.8%, a 30-year high, nearing the 3% warning line set by the Ministry of Finance when compiling the 2026 fiscal year budget. Once this level is breached, debt servicing costs will rise significantly, directly squeezing the government's other expenditure space. An informed source admitted: "The Japanese government's least desired outcome is a rise in bond yields."

Nomura Securities interest rate strategist Masumi Iwashita proposed a market-resonating "two-track strategy": advancing interest rate hikes and suspending debt reduction simultaneously. She believes that interest rate hikes can alleviate concerns about the policy lagging behind the situation, while suspending debt reduction can simultaneously suppress upward pressure on yields, forming a hedge and avoiding market turmoil caused by single operations. She clearly predicts that the Bank of Japan will suspend the reduction of bond purchases in fiscal 2027.

Former Bank of Japan officials Nobuhide Takei and former member Seiji Sakurai both publicly expressed support for suspending debt reduction. Sakurai pointed out that considering recent bond market volatility and the progress the Bank of Japan has made in reducing its balance sheet, it is a reasonable choice to stop reducing bond purchases in fiscal 2027. Takei was more direct: "Given the current political headwinds, I believe the Bank of Japan has no reason to continue reducing bond purchases in the next fiscal year."

Political resistance is also not to be ignored. The Takashi Shiozawa government's advocacy for tax cuts and increased spending, relying on debt funding, has a fundamental tension with the direction of the Bank of Japan's quantitative tightening. Former Goldman Sachs senior economist of the Bank of Japan, Akira Otani, pointed out that inflation risks brought by the situation in the Middle East, combined with proactive fiscal policy, are already pushing up yields, and further debt reduction will only exacerbate political friction.

Noteworthily, even if the Bank of Japan suspends the reduction of bond purchases in fiscal 2027, its approximately 500 trillion yen bond holdings will still naturally shrink due to maturities, and the balance sheet has shrunk by about 20% compared to its peak in 2023. The Bank of Japan will release the summary of its discussions with bond market participants next week, when the policy direction for fiscal 2027 will become clearer.