Japan’s expansionary fiscal push is testing the market’s patience

They say that “a bird in hand is worth two in the bush”, but Prime Minister Sanae Takaichi appears to believe the opposite: free the bird from its cage and trust that people will reward the gesture – and they did.  

On 23 January, Prime Minister Sanae Takaichi dissolved Japan’s lower house and called for a snap election on 8 February. The high-stakes move is unusually fast, considering that it has been less than six months since she took office. Commentators describe this as either a bold statecraft or a major gamble, with the odds seemingly in her favour but not so much for her political party. The move appears justified given her strong approval rating, especially among young voters.

The economics of zero food tax

At the core of Takaichi’s economic platform is a proposal to suspend the 8 per cent consumption tax on food for two years. The aim is to ease household burdens at a time when food prices remain high and visible. Politically, the move is intuitive: food is purchased frequently, price increases are immediately felt, and tax relief shows up directly at the checkout. However, from the market’s perspective, the proposal raises deeper concerns about the potential revenue decline, bond supply, and the balance between fiscal ambition and fiscal discipline.

Investors are right to be watchful, as a consumption tax suspension is not only a cost-of-living intervention but also a revenue decision with heavy public finance consequences. Japan’s consumption tax is one of the government’s most dependable revenue streams as it finances a meaningful share of general account spending. As Graph 1 shows, consumption tax has contributed over JPY 21 trillion (USD 135 billion) or 20 per cent of national revenue on average since 2022.

A lower tax take from food items means less public funding, which can be directly remedied in two ways: either the government reduces spending on social services and other subsidies, or it resorts to additional borrowings to plug the emerging consumption tax gap. The first option will likely generate greater dissatisfaction and erode Takaichi’s political capital while option two would further jack up Japan’s debt burden, which is hovering at 240 per cent of GDP as of end-2024. Investors generally frown upon high leverage, and this does not help Japan’s case.

While everyday voters may marvel at the idea of reduced food prices, economists tend to be wary of the proposal. In a recent joint survey by Nikkei and the Japan Center for Economic Research, over 80 per cent of economists disagree with the idea that removing the consumption tax on food will exert a positive spillover effect on the economy. It is actually quite the opposite, wherein such a tax cut may further exacerbate inflation due to potential increased demand. In an environment already battling labour shortage and stagnant wages, this would be a greater challenge for food producers.

Go big or go home

Takaichi is not alone in chasing fiscal symbolism. While she only aims to suspend the tax for two years, opposition groups such as the new Centrist Reform Alliance call for an indefinite suspension of the food consumption tax. However, none of the proposals can guarantee a sustained inflation decline in the long run. Consumption may revert to pre-tax levels should Takaichi win the snap elections or if the opposition were to fail in raising an additional JPY 5 trillion (USD 32 billion) to cover revenue losses without straining public finance even more.

Clearly, all political parties seem to be focused on expanding their fiscal symbolism as rapid-fire options to curb inflation. The political message is coherent: cushion the pain now, worry about consolidation later, and trust that faster GDP growth or higher revenues will fill the gap. Takaichi’s might shone during the polls, with her gamble paying off as her Liberal Democratic Party snagged a supermajority in the Lower House, clearing the runway for legislation to implement her fiscal reform plans.

Whether Japan has entered a phase of expansionary fiscal policy or not is a question that has now dominated market signals. If the loose fiscal policy continues while the Bank of Japan (BOJ) remains cautious, the bond market may tighten conditions by pushing long-term yields higher. One is left to wonder how soon the BOJ would react as the “core-core” inflation – a measure that excludes fresh food and energy items – has remained above the BOJ’s 2 per cent target.

The market’s response to this new dynamic has been clear. Since Takaichi took office and made her expansionary fiscal largesse known, both of Japan’s short- and long-term bond yields have been on an upward trend. Graph 2 captures the market’s reaction, especially around major events since October 2025.

In the current ageing environment of Japan, removing the food consumption tax is tempting precisely because it is easily observable and broad-based. Cutting it can buy the people’s goodwill quickly, though restoring it later may be politically difficult – just as hard as it was to implement in the first place.

Takaichi bet that voters reward generosity and boldness in easing the public’s woes. Meanwhile, the bond market’s bet is that generosity without a credible funding source eventually costs more than it delivers. The outcome of the February election is a collective decision on which choice looks smarter. It is clear that the markets understand the asymmetry, and it is one reason why the yield curve has been reacting so quickly to the discussion of fiscal expansion for debt-heavy Japan.

This original article has been produced in-house for Lundgreen’s Investor Insights by on-the-ground contributors of the region. The insight provided is informed with accurate data from reliable sources and has gone through various processes to ensure that the information upholds the integrity and values of the Lundgreen’s brand.