The Bank of Japan has just raised rates nominally, what should Japan do in the tariff economy led by the USA

Japan, what more can you say about this great nation. It has inspired historians, novelists, economists, artists and technologists to create, think and become the best based on its working principles.

If one were growing up in India, in the eighties and nineties, you got used to the aspirations built by Suzuki and Toyota. If one were a gamer one got their first view into the world through a Nintendo gaming machine. If one were a runner then you got a pair of Asics to train with.

The Japanese have been part of Indian life and have shaped the lives of Indians positively.
Japan continues to be a respected country albeit it has suffered so much pain over the last forty years. More on the pain and suffering as we read this article.

Coming out of deflation

Not many of us understand what is happening in Japan and how Japan is now trying to find its feet in a world of globalisation that is crumbling, thanks to the Americans who want to keep their hegemonic power of the dollar by imposing tariffs on everyone who is exporting goods to the USA. If Japan signs up with America again, it stands to suffer all that it has suffered thanks to the Plaza Accords of 1985.

Economists believe that American tariffs and nationalistic geo-politics are paving the way to a new global order.

Economists also believe eventually the dollar may lose its economic strength because the world may choose an alternative currently to replace it. America’s trade war against everyone is going to isolate it and at the centre of all this are its old allies Japan and Britain. The reason we are looking at Japan in this article is because the nation is truly making a comeback after a remarkable long period of deflation and low growth. However it’s caught in the cross fire of the tariff wars. Track the bond trades and you will see what is happening in Japan.

Bond trades

Of late due to various factors Japan’s bond yields are rising, which have increased yields for the buyers. This has led the Japanese government to forcibly raise rates on new bonds to match rising yields.

Now what this does is that it takes away the almost zero interest advantage that Japan possessed, as a weapon, to keep its country from going into an economic slowdown thanks to inflation. It had already suffered under the icy pangs of deflation.

To begin with, the current tariff regime of the USA will hurt the value of the Yen and increase inflation, which is why the Bank of Japan is raising rates slowly.

Will this hurt the Japanese economy?

The key is wage inflation

According to Deloitte the main impediment to stronger domestic consumer spending is inflation.

In Japan there is wage growth and inflation, which has led to the rise of fresh food prices and energy.

According to Deloitte wage growth is expected to remain relatively strong. Early indications of this year’s shunto—the annual wage negotiations for Japan’s unions—show signs of another year of solid wage growth. For example, a major union, Rengo, is asking for a pay rise of 5 percent or more. Last year’s shunto ultimately yielded a 5.1 percent wage increase.

If you take away food and energy prices the underlying inflation remains relatively calm. Japan is expected to release some of its emergency rice stockpiles to limit food inflation,but policymakers only have so much control over commodity prices.

So, why have JGB yields soared? It has soared because of amid sticky inflationary pressure and resultant rate hike expectations.
Inflationary pressure has reduced the effectiveness of bonds as a diversifier; gold has potential to help local pension portfolios improve their risk-return prospects.

After a sizable rise in 2024, the 10-year Japanese government bond (JGB) yield has climbed further in 2025 to date. The Bank of Japan (BoJ) waved goodbye to its negative interest rate policy as it implemented two rate hikes in 2024, sending local yields soaring.

An additional 25bps hike in January 2025 lifted the policy rate to 0.5 percent and this, together with intensifying expectations of further rate rises, has pushed up the 10-year JGB yield to its highest since October 2008.

Despite several hikes, the policy rate in Japan is still far lower than it is in most developed economies. The central bank’s tentativeness around hiking rates likely reflects competing signals. On one hand, headline inflation has been running above its 2 percent target since April 2022.

At the same time, the labor market has tightened, with wage growth accelerating. Higher rates would help get inflation back down to target by weakening demand and strengthening the exchange rate. But will the tariffs create a harmful situation for Japan?

The US tariffs can hurt Japan

We need to look at history as to why Japan will be hurt even this time around by the USA.

The writing is on the wall to weaken the Yen once again. Although a weaker currency makes exports lucrative, data shows that Japanese exports to the USA and China are coming down. The weak Yen is one of the reasons why the Bank of Japan is worried about inflation.

Think about it Japan also runs a sizable trade surplus with the United States, which amounted to US$62.6 billion for the first 11 months of 2024.

Policymakers in the United States have cited trade imbalances as a reason to use tariffs against them. As a result, Japan could find itself in a similar position as the rest of the world, but Japan can have it worse.

Unlike the Chinese, the Japanese are at the mercy of the United States of America for historical reasons. The Americans still have a large military base in Okinawa and have practically controlled the Japanese since. One only has to study the Plaza Accords to know the reason why Japan suffered after 1985.

When the Japanese economy was rising between 1950 and 1985 its imminent dominance was brought to a halt by the USA to benefit American corporations. To control the rise of the Yen, the USA increased the value of the dollar in 1985 relative to the Yen, which meant that a dollar which bought ¥150 was now worth ¥250. This made Japanese exports expensive and was curtailing domestic growth.

This led the Bank of Japan to cut rates to boost the domestic economy, which increased prices of shares, land and every asset.

For almost a decade nobody complained about the artificial rise of the market. Even pension funds were invested in the stock market. This artificial rise where share prices were a mark of an economy than the underlying business, became a central point of contention. The era of domestic expansion was coming to a halt.

By 1994 the Japanese economy had collapsed, property prices were only 1 percent of their original peaks. 60 percent of the savings of the Japanese people were wiped out and entire generation was living on a day to day basis. Read more about it here. By the time it fixed the rot, it had to contend with the global recession of 2008.

This was why Japan had to revive its economy in a zero interest rate regime to control deflation, which has now lasted for almost 18-years and has ended.

Things are changing rapidly as we speak.

These JGBs which were once valuable for their coupon rates are now only worth because of their yields, which is also the reason why the Japanese Government is forced to issue new bonds with higher coupon rates to counter the rising yields. If this balancing act goes wrong the Japanese economy will have to brace itself for another slowdown and rising inflation.

For Japan to stay relevant and revive its economy it has to embrace new partners and markets. It must be bold enough to distance itself from the USA and negotiate the tariff regime. It should never be in a position where it signed itself to be in 1985. The Japanese have to embrace global partners and India is just about the partner it has to embrace for its future. More on this in our next article.