Japan’s financial markets remain vulnerable to signs of looser fiscal policy, a former senior currency official warned, saying the prospect of additional sales tax relief could prompt a fresh wave of selling in government bonds and the yen akin to Britain’s "Truss shock."
Hiroshi Watanabe, who served as vice finance minister for international affairs and handled Japan’s currency policy while coordinating economic policy abroad from 2004 to 2007, said markets were watching the ruling Liberal Democratic Party for any tilt toward broader tax cuts as it seeks to shore up voter backing during a campaign.
"We’re somehow managing to hold the line for now, but it’s right at the edge," Watanabe told Reuters in an interview. He now holds a position as a visiting professor at Tokyo Seitoku University.
Prime Minister Sanae Takaichi has called a snap election for February 8 as she looks for a mandate to pursue policies aimed at reflating the economy. Last month, markets reacted sharply after Takaichi pledged a temporary cut in the consumption tax on food for two years, reviving investor concerns about Japan’s fiscal trajectory in a country whose public debt exceeds twice the size of its economy.
That pledge contributed to a wide market rout: super-long Japanese government bonds sold off noticeably and the yen weakened toward levels that in the past had prompted yen-buying intervention. Since that episode, markets have somewhat stabilised, with the yen recovering to about 154 per dollar amid speculation that Japanese and U.S. authorities had carried out rate checks - a move often seen as a precursor to outright intervention.
Watanabe emphasised that investors would react strongly to any indication the scope of tax relief might be expanded beyond current commitments. He said he believes Prime Minister Takaichi and Finance Minister Satsuki Katayama have registered warnings from global capital markets, and that caution from major U.S. and European investors likely moderated policymakers’ public statements.
On the outlook for the currency, Watanabe pointed to a combination of concerns - Japan’s public finances, a structural trade deficit, and unclear guidance on the Bank of Japan’s rate path - that he said would constrain a sustained yen recovery. "There is a possibility that the yen could briefly move into the 140s per dollar," he said. "But it’s hard to see a situation where yen appreciation continues."
Contextual note: The comments underscore how fiscal policy discussions tied to an election campaign can quickly influence investor sentiment in a market already sensitive to policy shifts. The authorities’ responses and any further details on fiscal commitments will likely determine whether the recent calm holds or volatility returns.