Deutsche Bank: Japan may shift policy focus from supporting the yen to controlling government bond yields to support economic growth plans.

Deutsche Bank stated that in order to achieve the ambitious economic growth targets set by the Japanese government, Japan may need to shift its policy focus from supporting the yen to controlling government bond yields to reduce financing costs and ensure fiscal sustainability. Japanese Prime Minister Taro Aso announced an economic growth plan of around $2.3 trillion at the end of last month. Mallika Sachdeva, a strategist at Deutsche Bank, pointed out in a recent report that this plan signifies that Japan is at a critical juncture of major transformation in fiscal and industrial policies, where the government needs to expand fiscal spending while maintaining fiscal sustainability. According to the growth plan, the Japanese government hopes to activate domestic savings, encourage large institutional investors to increase their allocation to domestic assets, and provide a source of funding for large-scale fiscal spending. At the same time, Japan also needs to ensure that nominal economic growth remains higher than financing costs to maintain debt sustainability. Sachdeva believes that in order to achieve these two objectives, the Japanese government may need to take measures to lower government bond yields and control overall financing costs. This means that the policy focus in Japan may shift. In the past, the Japanese government and the Bank of Japan have been focused on curbing the depreciation of the yen, including multiple interventions in the foreign exchange market, but with limited success. The yen fell to its lowest level in about 40 years earlier this week, and then rebounded somewhat after reports that Bank of Japan officials are willing to raise interest rates faster than market expectations. Sachdeva states that if enhancing fiscal capacity becomes the primary policy objective, Japan's future policy focus may shift from foreign exchange management to yield management, from focusing on the USD/JPY exchange rate to controlling the 10-year government bond yield and overall borrowing costs. In fact, Japan implemented Yield Curve Control (YCC) policy from 2016 to 2024 to lower financing costs. Other countries, such as the United States, have also adopted similar policies in the past, such as during World War II when the US controlled government bond yields for war financing. Deutsche Bank points out that Japan is not the only developed economy facing high debt pressure while seeking to revive economic growth, but due to the fact that the Japanese government debt-to-GDP ratio has exceeded 200%, its fiscal policy space is significantly smaller than other major economies. Concerns about debt sustainability are already reflected in the bond market. Japanese long-term government bond yields have been rising consistently this year, with the 30-year Japanese government bond yield reaching historic highs. Sachdeva predicts that Japan is more likely to manage long-term yields by influencing bond demand in the future. One way could be to require the Government Pension Investment Fund (GPIF), with a size of around $1.8 trillion, to increase its allocation to domestic assets to increase demand for Japanese government bonds. Another possibility is for the Bank of Japan to increase its support for the bond market, including resuming government bond purchases or maintaining loose monetary policy to help control yields. However, she points out that if the Bank of Japan resumes bond purchases or maintains loose policy, it may put pressure on the yen; conversely, if the GPIF returns some overseas assets to Japan, it could provide support for the yen. Sachdeva states that in the future, as Japan aims to suppress volatility in government bond yields, fluctuations in the foreign exchange market may also intensify.