Japan's Record $785B Budget Braces for a 3% Interest Rate Shock

Japan's government is finalizing a record $785 billion budget for fiscal 2026, assuming a 3% interest rate for debt servicing. The move signals a major shift away from the era of ultra-low rates.

Japan is bracing for a world with higher interest rates. Prime Minister Sanae Takaichi's government is finalizing a record-breaking fiscal 2026 budget of 122.3 trillion yen ($785 billion), built on a crucial assumption: a government bond interest rate of roughly 3%. This signals a major fiscal shift in preparation for the end of the country's era of ultra-low borrowing costs.

Record Spending for a Second Straight Year

According to Nikkei, the cabinet is expected to approve the draft budget as early as December 26. If passed, it would mark the second consecutive year of all-time high government spending, raising further alarms in markets already concerned about Japan's massive public debt.

The 3% Assumption Is Key

The most significant detail in the draft budget is the assumed interest rate used to calculate debt-servicing costs. By setting it at approximately 3%, the government is fiscally acknowledging the potential for the Bank of Japan (BOJ) to normalize its monetary policy. A rise in interest rates would cause Japan's debt-servicing payments to balloon, putting immense pressure on public finances.

Investors in Japanese Government Bonds (JGBs) should be cautious of the risk of rising rates, which would lead to falling bond prices. The government's new rate assumption could be a harbinger of increased market volatility.

Record Spending for a Second Straight Year

The 3% Assumption Is Key

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