Japan’s new fiscal stimulus to target inflation as JGB concerns mount

Japan's stimulus package targets inflation stabilisation, strengthening defence and diplomacy, and sustainable growth. It should spur short-term growth and reduce inflation, but may put pressure on JGBs. The BoJ's policy normalisation will likely continue, though it faces challenges and may proceed at a slower pace.

Larger than expected fiscal stimulus package introduced

The Japanese government has approved a ¥21.3 trillion economic package (3.5% of GDP), allocating ¥11.7tr to inflation control and childcare support. Since ¥17.7tr will be drawn from the general account spending, an extra budget will probably be needed. The market anticipates that another ¥7tr in Japanese government bonds (JGBs) will be issued. Because this government is a minority government, the final package ended up larger than initially intended in order to meet opposition parties' demands, such as abolishing the gasoline tax and raising the income tax-free threshold.

The subsidies for gas and power bills for the first three months of 2026 are expected to push down the overall inflation gauge by an average of 0.7ppt during the period, while cash payouts and aid to revitalise the local/rural economy are expected to boost GDP growth by 1.4ppt per year over the next three years.

Economic package will boost near-term growth while curbing headline inflation significantly

Should the package gain approval in parliament with backing from opposition parties, it may result in a significant increase in GDP during the first half of 2026. We have to monitor how the final package is shaped, but given the considerable size of the bill, it will likely boost near-term growth. In turn, we now expect GDP to grow 1.4% year-on-year in 2026 (vs 0.7% currently).

For inflation, the energy subsidy will lower headline inflation quite meaningfully during the wintertime, although it should be partially offset by the weaker yen. Headline inflation is expected to fall below 2% throughout next year. However, core-core inflation excluding food and energy is likely to remain above 2% for a considerable time.

Reflecting on the inflation measures, we have revised down our CPI outlook for 2026. We now expect headline inflation to rise 2.0% YoY (vs the current 2.3%), and core-core inflation to increase 2.6% (vs 2.7% currently) as the stimulus package strengthens demand side pressures and keeps the JPY under pressure.

Pressures on JGB will continue

The yield on the 10-year JGB rose to around 1.8%, reflecting investor expectations of additional bond issuance. The current political environment may also limit the pace of the Bank of Japan's monetary policy normalisation, potentially allowing elevated core inflation to persist.

We believe that the pressures on the JGB will continue to build until it reaches 2.0%. This will mostly justify sustainable inflation growth of 2.0% in our view. We've therefore revised our JGB outlook from the current 1.75% to 1.90% for the first quarter of 2026 and from 1.8% to 2.0% for the year's second half.

BoJ watch

We maintain the view that the Bank of Japan will continue on its path toward policy normalisation, with a total of 50bp in rate hikes by the end of 2026. However, the exact timing remains uncertain. Elevated inflation and a robust economic recovery could prompt the BoJ to implement a rate hike as early as December.

Still, if politics influence monetary policy, then the BoJ may postpone action until next January – or beyond, possibly until March or April, depending on the spring wage negotiation results. We will see a few major data releases next week, including Tokyo CPI and monthly industrial production, so we will adjust our BoJ view according to the data and other economic developments.

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