The present crisis in the Middle East has affected Japan in two main ways. The first is via its position as a large energy importer. You can look at Japan as importing energy ( and other commodity resources) to produce goods in exchange and in that model the terms of trade have moved against it. Also there has been the role of the Bank of Japan and the way it in its The Tokyo Whale incarnation has tried to control everything. Want cheap bond yields no problem it will buy hundreds of trillions of Yen worth of them and keep yields at 0% or ZIRP for many years. Want a higher stock market? The Tokyo Whale can buy that too. It bought some 37.1 trillion Yen of that mostly targeting the Nikkei 400 index and as we stand it is worth a bit more than 80 trillion Yen. I am being a little vague because with stock markets being so volatile precision is somewhat misleading. Of course the volatility is what the buying was supposed to stop at least the downwards part although we are now at much higher levels. Finally there were the more recent threats to intervene in the Yen exchange-rate when it exceeded 160 versus the US Dollar.
On its track record it would have been intervening in energy markets at the moment but of course you cannot print energy.
The Interest-Rate Problem
This has become quite an issue and the Financial Times has published a piece which covers it in rather extraordinary terms.
That weirdness is helpful. The situation is becoming exactly abnormal enough for the Bank of Japan to normalise interest rates at long last.
The word “normalise” has become a rather broad church but let’s say 2.5% to 3% interest-rates are what this typically means. But apparently not.
At the end of April and barring a very significant escalation in the Middle East, there is a good chance that the BoJ will move its policy interest rate a quarter point higher to 1 per cent. Sniff the bouquet and roll it around the palate: this is the vintage the monetary one-o-philes have been waiting for.
I have never met a “monetary one-o-phile” and wonder if that concept is the product of a very active imagination? But don’t worry there is more.
The significance of a shift to 1 per cent would not simply be the bravery of such a move by bank governor Kazuo Ueda, or the 30-year odyssey of oddity that led here, but the unmissable intent of the integer.
What is the “unmissable intent of the integer”? After all many Japanese interest-rates are much higher. This week’s podcast had a question about the significance of Japan’s forty-year yield reaching 4%? At the risk of a spoiler I did not answer it was four times the unmissable intent of the integer.
The next part completely ignores the reality that the Bank of Japan has raised interest-rates as slowly as it thinks it can get away with.
Hitting the 1.0 threshold is the psychological opposite of a shop “charm pricing” an item at 99p to trick the consumer’s brain. One per cent, after so many years of Japan’s hand-to-mouth monetary policy, feels like a plate ready for more to be heaped upon it.
The reason is its large Japanese Government Bond position and I have been pointing out this issue since October 2nd 2023.
First, the Bank’s income has been on an increasing trend.
Interest income on the government bonds has been rising following the increase in the purchases of long-term JGBs. In addition, the dividends received from its holdings of ETFs and other assets have grown to a sizable amount over the past few years.
Back then I did the maths.
Well played the Bank of Japan. On Wednesday when they buy the extra bonds they will get 0.75% or so a year and only pay their interest-rate of -0.1%. So more profits.
As they have raised interest-rates they have raised the rate they charge themselves. With so many bonds bought at a yield of 0% even an interest-rate of 0.75% is expensive and 1% even more so. If we look back to February 6th last year here are the words of Bank of Japan Board Member Tamura-san.
My sense is that the neutral interest rate would be at
least around 1 percent. Therefore, I think it is necessary for the Bank to raise the short-term interest rate to at least that level by the second half of fiscal 2025 to contain the upside risks to prices and achieve the price stability target in a sustainable and stable manner.
There are two major issues here. Firstly direct forward guidance of interest-rates of “at least” 1% whereas fourteen months later it is only 0.75%. Plus a rather desperate effort to claim the neutral interest-rate is around 1%. Whereas if you look at the ten-year yield which has been freed of some of the central control and take the view it is a forecast of interest-rates over the next ten years then at 2.38% it is suggesting at least 2%.
On the 27th of March a Bank of Japan working paper tried to claim this.
The results show that, as of 2025/Q3, the estimates of the natural rate of interest across the six models were in the range of around -0.9 percent to +0.5 percent.
I doubt they even convinced themselves.
Quantitative Tightening or QT
This issue is crucial for The Tokyo Whale which not only has large capital losses but as I have just explained now has interest or carry ones too. Along the way it has introduced a different form of QT. It is still buying bonds so undertaking QE.
Meanwhile, in December 2025, the Bank conducted Japanese government bond (JGB) purchases of about 3.3 trillion yen per month. In January 2026, it cut down the monthly purchase amount by about 400 billion yen, to about 2.9 trillion yen per month; this was in accordance with the JGB reduction plan decided at the June 2025 meeting.
But because they own so many bonds have matured faster than this the balance sheet is shrinking and so far has done so by around 50 trillion Yen. Thus whilst that is a lot it is still left with 530 trillion Yen where the capital losses keep getting larger and now interest ones are in play, which is why it has been so unwilling to raise interest-rates.
We have gross QE but net QT
Comment
As you can see this has been a case of the tail wagging the dog. Let me give you an example of this and here again is the Financial Times.
First, on a number of measures Japan’s economy is running fairly hot. Union-secured wage hikes were above 5 per cent for the third straight year.
This has been a constant media theme and is the official line. Except as I have pointed out over the years the real world is different.
TOKYO — Salaries for key technology roles in Malaysia have overtaken those in Japan for the first time, driven by rising investment in the Southeast Asian country’s booming semiconductor industry and intensifying competition in digital sectors, a report released Wednesday showed. (Nikkei)
In fact this looks rather familiar and very different to the official rhetoric.
This surpassed Japan’s 26 million yen, which remained flat from a year ago.
So a growth area has flat wages? The numbers claimed never seem to add up.
In contrast, Japan lagged its regional peers, reflecting relatively slow salary growth despite recent wage momentum.