The Bank of Japan’s historic shift away from ultra-loose monetary policy is firmly underway, and signs of tension are starting to emerge across global bond markets.
At its December meeting, the BoJ raised its key short-term policy rate by 25 basis points to 0.75%, the highest level since 1995.
While the move itself was widely expected, the tone surrounding it was not.
Governor Kazuo Ueda leaned toward a hawkish stance, underlining that Japan’s era of extremely low interest rates is drawing to a close, and that the implications may stretch far beyond Tokyo.
A hawkish shift from the BoJ
In its policy statement, the BoJ emphasised that “real interest rates are expected to remain significantly negative” and that accommodative financial conditions would continue to support economic activity.
At the same time, it reaffirmed that if the growth and inflation outlook outlined in its October Outlook Report materialises, the Bank will “continue to raise the policy interest rate and adjust the degree of monetary accommodation”.
Ueda reinforced that message during his press conference, warning that delaying policy adjustment could ultimately necessitate sharper rate increases. He also noted that previous hikes have yet to exert a meaningful tightening effect and stressed that policy rates remain some distance from the lower bound of the Bank’s estimate of neutral.
Taken together, the message was unambiguous: The BoJ is firmly in hiking mode.
‘Pretty historic’: Analysts weigh in
“The BoJ delivered a hawkish hike,” said Dariusz Kowalczyk, analyst at BBVA, highlighting the clear commitment to further normalisation.
“I know it’s only three-quarters of a percentage point, but it’s pretty historic,” said Bart Wakabayashi, branch manager at State Street in Tokyo. “We haven’t been at this level for three decades, so I think it’s a significant move.”
Goldman Sachs’ chief Japan economist, Akira Otani, warned that this is not the BoJ end point on raising interest rates, and the decision reinforces a gradual but persistent hiking bias.
Why does this matter so much beyond Japan?
The answer lies in the country’s outsized role in global bond markets.
Japan remains the world’s largest net creditor, with a net international investment position of around $3.66tr (€3.12tr) as of September 2025.
For years, Japan’s rock-bottom interest rates incentivised capital outflows. Japanese institutional investors, including pension funds and insurers, have poured trillions into foreign bond markets, particularly US Treasuries and European government debt.
But as domestic bond yields rise, even marginally, that incentive diminishes. The result is a potential reduction in foreign bond buying, what many economists refer to as Japan “repatriation”.
When domestic yields are low, Japanese institutional investors tend to seek better returns abroad, often in US Treasuries, European government bonds, or emerging-market debt.
But as Japanese yields rise, that incentive weakens. Even modest changes in relative returns can alter portfolio allocations at the margin, raising the risk of capital being repatriated back into Japanese assets.
This dynamic is already visible in narrowing yield differentials.
The gap between 10-year US Treasuries and Japanese government bond yields has contracted to 2.12 percentage points, its lowest since March 2022.
The spread between 10-year Bunds and JGBs has similarly fallen to 0.85 percentage points, the lowest in over three years.
As those spreads compress, Japanese investors may begin to redirect capital back home, leaving global bond markets to absorb the slack.
Cracks in global yields
Bond markets have already begun to respond. Germany’s 30-year bond yield surged to 3.51% on the Friday following the BoJ decision, its highest since July 2011.
Such a move in Europe’s largest economy, often seen as the world’s fiscal anchor, is a warning sign.
The risk is not confined to Europe. Rising Japanese yields threaten to upend global investment flows, especially through the unwinding of the yen carry trade.
With ultra-low Japanese rates providing cheap funding, investors have long used the yen to finance bets on higher-yielding assets abroad. That strategy, which has worked well for decades, is now under pressure.
As Japanese rates rise, the advantage of borrowing in yen becomes less appetising for global investors.
The result could be a wave of deleveraging across global credit and equity markets, triggering a disorderly rise in yields.
While the pace of rate hikes is likely to remain gradual, the direction of travel is clear. The BoJ is no longer the perennial dove of the developed world.
For investors, the message is simple and increasingly hard to ignore: Japan matters again.
