IMF warns that Japan may need to raise interest rates faster, adding further pressure to global bond markets?

Title context: IMF warns that Japan may need to raise interest rates faster, adding further pressure to global bond markets? Text: The International Monetary Fund has rarely endorsed the normalization of Japan's monetary policy and warned that if inflation exceeds expectations, the Bank of Japan may need to accelerate the pace of interest rate hikes. This statement, at a time when global bond markets are already turbulent, has further heightened market concerns about Japanese capital withdrawing from overseas assets. Krishna Srinivasan, Director of the IMF's Asia and Pacific Department, said in an interview with Reuters during the IMF annual meetings held in Bangkok this week that the Bank of Japan "is doing the right thing," and stressed that if inflation rises faster than expected, "you have to tighten faster because you don't want inflation expectations to become unanchored. It depends on the data." Bank of Japan Governor Kazuo Ueda also reiterated while attending this IMF annual meeting that the central bank will focus on anchoring core inflation near the 2% target and will not tolerate any overshoot, further strengthening market expectations for another rate hike within the year. The IMF's statement comes as global bond markets are under pressure. The yield on France's 10-year government bond briefly approached 5%, the highest since 2002, with borrowing costs now higher than those of Greece and Italy; the U.S. 10-year Treasury yield climbed to a multi-decade high of 5.28%, and even weaker inflation data failed to curb the selloff. In the view of some market analysts, Japan's policy normalization and the resulting repatriation of Japanese capital may be structural forces that cannot be ignored behind these two episodes of turmoil. Expectations for faster BOJ normalization are rising The Bank of Japan has already raised interest rates in June and September of this year, pushing the policy rate up to 1.25%, the highest in 31 years. Most analysts expect at least one more rate hike within the year. Srinivasan pointed out that the weak yen has further pushed up the cost of raw material imports and intensified domestic inflationary pressure, which is also one of the important backgrounds prompting the Bank of Japan to continue tightening policy. The Bank of Japan will hold a key policy meeting later this month, and the market widely expects rates to remain unchanged at that time, but it may send a hawkish signal to pave the way for a December rate hike. In addition, inflation risks brought by the Middle East conflict and strong demand for artificial intelligence also became important topics discussed by policymakers from various countries at this IMF annual meeting. IMF: Yen intervention does not violate floating exchange rate commitment On exchange rate issues, the IMF endorsed the position of Japanese authorities. Srinivasan said Japanese authorities are "fully committed to a free-floating exchange rate regime," and that he has had multiple discussions with the Japanese side and has "no doubt" about this. In the analytical chapter of its Asia economic report, the IMF pointed out that the large fluctuations of the yen since mid-2025 are largely not closely related to fundamentals such as yield differentials, but instead moved in sync with speculative positions in yen futures. On July 31 this year, Japan conducted a rare coordinated intervention with the United States to prevent the yen from falling to a nearly 40-year low. Srinivasan said Japan's foreign exchange market is sufficiently deep, and authorities regard exchange rate volatility as the "first line of defense," with intervention used only under specific circumstances. In addition to monetary policy, Japan's fiscal sustainability also leaves the market doubtful. The market is concerned that the Japanese government's large-scale spending plans, combined with a two-year consumption tax cut starting in April next year, will further expand an already huge debt burden. Srinivasan acknowledged market concerns about fiscal risks, but also pointed out that since the pandemic, Japan's fiscal consolidation efforts have actually exceeded those of any other G7 country, partly due to sustained growth in tax revenue. He also stressed that Japan needs to clarify the funding sources for new spending and tax cut plans and establish a medium-term fiscal framework to stabilize market expectations. Japanese capital withdrawal may exacerbate global bond market volatility The link between turbulence in global bond markets and Japan's policy normalization process is attracting increasing attention. According to an analytical article by Bloomberg columnist Gearoid Reidy, the world may not be fully prepared for "a Japan with interest rates," and France may only be the first market to be hit. Data show that as of July this year, Japanese investors held about 23 trillion yen (about $145 billion) of French government bonds, making it Japan's largest overweight position in the euro area. However, as the yield on Japan's 10-year government bond rose above 3% last month, a 30-year high, the yield advantage of French 10-year government bonds over Japanese government bonds after currency hedging has narrowed to about 40 basis points, and its attractiveness has fallen sharply. The fading yield advantage, combined with the deterioration of France's fiscal situation, has begun to loosen Japanese capital. Data show that the scale of Japanese holdings of French government bonds has decreased by 2.5% from the end of last year. A global fixed income fund managed by Shinji Kunibe at Sumitomo Mitsui DS Asset Management has liquidated French bonds due to fiscal concerns. Masayuki Nakajima of Mizuho said: "Even if valuations look cheaper, Japanese investors' incentive to rebuild positions is declining." As the IMF provides policy support for Japan to accelerate rate hikes, the continued recovery in the attractiveness of Japanese domestic assets may extend this trend and create sustained structural pressure on overseas bond markets that rely on Japanese capital. This article is reprinted from "Wallstreetcn," author: Zhang Yaqi; GMTEight editor: Yan Wencai.