Japan’s 2-year government bond yield rose to 1%, the highest in 17 years.

On Monday, the yield on Japan’s 2‑year government bond climbed to 1%, the highest level in 17 years. The rise reflects growing market expectations that the Bank of Japan (BOJ) may soon begin raising interest rates.

This development comes ahead of a speech by BOJ Governor Kazuo Ueda in Nagoya. Japan’s currency strengthened as much as 0.3% to 155.71 per dollar.

“Growing expectations of a BOJ rate hike are helping the yen appreciate and putting upward pressure on the two-year JGB yield,” said Hirofumi Suzuki, chief FX strategist at Sumitomo Mitsui Banking Corp. “Governor Ueda’s comments today should be the key catalyst. If he sounds more hawkish than expected, I would expect this trend to continue.”

Amid these financial market movements, domestic corporate activity also showed signs of cooling. Japanese businesses reduced their capital spending over the summer, following five consecutive quarters of profits, which signaled a cooling of corporate sentiment as higher US tariffs took a toll.

The Finance Ministry noted on Monday that Capital expenditure on goods, excluding software, declined 0.3% from the previous quarter in the three months through September.

Preliminary GDP data, however, indicated that overall corporate investment grew by 1%.

Investor caution amid rate hike speculation

The swap market now assigns a roughly 62% chance of a rate hike ahead of the BOJ’s next policy decision on December 19, with a near-90 % chance at the January meeting. 

Only a few weeks ago, there were slim odds of a move in December — 30%. If the BOJ does follow through on a rate hike, the move, analysts warn, could further strengthen the yen, putting additional pressure on exporters and possibly cooling domestic demand. 

Yields increasing could have great effects on Japan’s public finances, which are already saddled with one of the world’s largest debts relative to its GDP. It may draw foreign capital back into Japanese bonds. Analysts say rising borrowing costs could ripple into domestic markets and impact global financial flows.

Conversely, elevated yields can attract foreign investment into Japanese bonds, thereby supporting the government’s fiscal program. Market participants will closely pay attention to Governor Ueda’s speech in Nagoya for clues on how aggressively the BOJ will act in the coming months.

Rising debt issuance adds pressure to bonds

Separately, the Ministry of Finance plans to increase issuance of short-term debt to fund Prime Minister Sanae Takaichi’s economic package. This includes raising issuance of two- and five-year notes by ¥300 billion ($1.92 billion) each and Treasury bills by ¥6.3 trillion, a move expected to weigh on shorter-term government bonds.

“It’s prudent to remain cautious” on bonds at the moment, said Ryutaro Kimura, senior fixed-income strategist at AXA Investment Managers. The market must account for “the anticipated re-acceleration of inflation under the fiscal expansion of the Takaichi administration and the deterioration in the supply-demand balance due to a substantial increase in medium-term JGB issuance.”

The rising speculation of a December hike comes as the yen has slumped 5% against the dollar this quarter, positioning it as the worst-performing among the Group of 10 currencies.

For some time now, Japan’s inflation has been running above the BOJ’s 2% target, drawing criticism that the central bank is behind the curve in raising rates. A short-term note auction held late last week drew weak demand, suggesting that investors are cautious amid growing concerns about interest-rate hikes.

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