The market is seeing a reduction in overweight positions in 10-year Japanese Government Bonds (JGBs), reflecting rising domestic inflation, yen weakness, high energy prices, and the Bank of Japan’s (BoJ) trajectory of gradual monetary policy tightening.
During the first half of 2026, inflation in Japan has remained at moderate levels compared to previous years, hovering below the official 2% target set by the BoJ. In fact, the monetary institution revised its median core CPI estimate downward to 2.5%, compared to the 2.8% previously estimated. Furthermore, the BoJ projects that core inflation will hover around 2.4% in FY27 and 2.0% in FY28, suggesting a progressive anchoring around the official long-term target.
Inflation Management
According to experts, this downward revision is primarily attributed to the temporary effect of government energy subsidies during the summer months, among other measures. “Japan has announced plans to reduce the consumption tax on food from 8% to 1% starting in April 2027, aiming to address cost-of-living concerns amid low public approval regarding inflation management. Although fiscal risks persist, retail and food and beverage companies are the primary beneficiaries,” notes Louis Chua, Asia Equity Analyst at Julius Baer.
In a press conference held on the afternoon of July 27, 2026, Japanese Prime Minister Sanae Takaichi announced that a proposal to reduce the consumption tax will be presented later this week, lowering the tax on food products from 8% to 1%, effective April 2027. To provide context, Chua explains that reducing the food consumption tax is a key campaign promise of the ruling Liberal Democratic Party (LDP), with the cost of living being one of the top concerns among Japanese citizens.
“According to the latest Yomiuri poll, only 21% of respondents approve of the government’s response to high inflation, while 71% disapprove, which may have contributed to the recent downward trend in the government’s approval ratings. A bill to approve the tax cuts will be submitted to the Diet of Japan following the conclusion of bipartisan debates, despite the opposition having previously opposed these cuts,” the Julius Baer expert points out.
Monetary Policy
This concern over the standard of living in Japan leads directly to analyzing the BoJ’s recent moves. Although it kept its policy rate unchanged at its July 30–31 monetary policy meeting, the Outlook Report contained several hawkish elements, such as upward revisions to its real GDP growth forecasts for fiscal years 2026 and 2027. However, Japanese sovereign bond futures experienced a mild bounce following the release of the statement and report. “Overall, markets did not seem convinced that the report provided sufficient justification to price in additional rate hikes,” BofA analysts note.
Nevertheless, they believe that whether markets assign a higher probability to a September rate hike will largely depend on the extent to which the Takaichi administration shows support for further increases. In this regard, the next key catalyst will be the Summary of Opinions, scheduled for publication on August 10, specifically the comments from the Cabinet Office representative attending the meeting.
“Governor Ueda’s statements during the press conference carried a somewhat hawkish tone. His comments, noting that the risk of Japan returning to deflation has diminished and that clear signs of a significant rise in inflation expectations have recently emerged, suggested the possibility of a faster pace of rate hikes. As a result, the market-implied probability of a hike at the September meeting has increased,” stated Tomonobu Yamashita, Interest Rate Strategist at BofA.
Intervention to Curb Yen Weakness
For BofA experts, a key takeaway from this BoJ meeting was that while hawkish elements were present, they were not sufficient to exert renewed downward pressure on USD/JPY after the pair had already been pulled lower by suspected foreign exchange market interventions.
In the view of Shusuke Yamada, FX and Rates Strategist at BofA, the risk of further yen depreciation persists if left unchecked. “If authorities allow USD/JPY to rebound upward, their credibility could be eroded, raising the cost of future interventions down the road. In our view, this is precisely the moment when authorities should firmly push USD/JPY lower and prevent a rapid return to the yen weakness trend. We continue to believe that a consolidated break below ¥155 could alter market dynamics in USD/JPY. Such a move could trigger a broader shift in positioning and flow patterns that have long favored yen weakness. As we see it, authorities should now demonstrate clear resolve to defend the currency,” Yamada argues.
In fact, authorities have already taken action. As explained by Sree Kochugovindan, Senior Economist at Aberdeen Investments, coordinated foreign exchange market interventions were conducted by Japan and the United States to help stem yen weakness. This marks the first coordinated intervention since 2011, which was aimed at curbing yen appreciation following the Great East Japan Earthquake.
“On July 30, at a strategically chosen moment—after the Federal Reserve’s policy meeting and prior to the BoJ’s—Japan’s Ministry of Finance (MoF) carried out an estimated unilateral intervention of between 8.5 and 10 trillion yen, while the Federal Reserve Bank of New York conducted rate checks. This helped spur a sharp, albeit only partially sustained, rally in the yen from multi-decade lows,” she explains. Subsequently, on July 31, Japan sold USD/JPY again, while the New York Fed sold EUR/JPY on behalf of the US Treasury via two US dealers.
In her view, over the short term, the combination of intervention risk, US backing, and a more hawkish BoJ stance increases the likelihood of further short-covering trades in USD/JPY, especially given the high level of speculative short positions on the yen.
“Further appreciation could also ripple across other markets as carry trades are unwound. This was previously observed in the summer of 2024, when a surprise announcement from the BoJ triggered a sharp rise in the yen. For Japanese Government Bonds (JGBs), growing concerns over yen-driven inflation and rising expectations of further BoJ tightening measures should maintain upward pressure on yields, particularly if exchange rate weakness resumes and strengthens the case for an earlier rate hike. However, over the long term, intervention alone is unlikely to reverse the trend without further normalization by the BoJ and narrower rate differentials,” the Aberdeen Investments expert concludes.
