Japan's government on Friday proposed record spending for next fiscal year while curbing debt issuance, underscoring Prime Minister Sanae Takaichi's challenge in boosting the economy while inflation remains above the central bank's target.
Her cabinet approved a draft budget of $783 billion that addresses market jitters by capping bond issuance and reducing the proportion of the budget financed by fresh debt to the lowest in almost three decades.
Also complicating Takaichi's policy challenge, core inflation in Tokyo stayed above the Bank of Japan's 2% target this month while the yen remains weak, bolstering the central bank's case to keep raising interest rates.
The record 122.3-trillion-yen budget for the year starting in April, a core part of Takaichi's "proactive" fiscal policy, will likely underpin consumption but could also accelerate inflation and further strain Japan's tattered finances.
DELICATE BALANCE OF BUDGET SUPPORT, DEBT RESTRAINT
Investor unease about fiscal expansion in an economy with the heaviest debt burden in the industrialized world has driven super-long government bond yields to record highs and weighed on the yen.
"We believe we have been able to draft a budget that not only increases allocations for key policy measures but also takes fiscal discipline into account, achieving both a strong economy and fiscal sustainability," said Finance Minister Satsuki Katayama.
She told a press conference the draft budget keeps new bond issuance below 30 trillion yen ($190 billion) for a second consecutive year, with the debt dependence ratio falling to 24.2%, the lowest since 1998.
The Takaichi government's efforts to reassure Japanese government bond investors were showing some success.
The 30-year JGB yield fell on Thursday from a record high 3.45% after Reuters reported the government will likely reduce new issuance of super-long JGBs next fiscal year to the lowest in 17 years. Yields slipped further on Friday on the administration's efforts at fiscal restraint.
The budget was not as large as initially feared, said Saisuke Sakai, senior economist at Mizuho Research & Technologies. "But political fragmentation raises the risk that Takaichi may resort to a large supplementary budget next year to secure opposition support, keeping alive market concerns that fiscal expansion could push the yen down and accelerate inflation," he said.
"It's too optimistic to assume that the current environment will persist."
The proposed spending is inflated by a jump in debt-servicing costs for interest payments and debt redemption.
It also reflects a 3.8% rise in military spending to 9 trillion yen ($60 billion) as part of the assertive defense policy of Takaichi, a conservative nationalist, and in line with a U.S. push for its allies to pay more for their own defense.
TOKYO INFLATION SLOWS BUT STILL POINTS TO RATE HIKES
The Tokyo core consumer price index, which excludes volatile costs of fresh food, rose 2.3% in December from a year earlier, less than market forecasts for a 2.5% gain and slowing from a 2.8% increase in November.
The data backs up the central bank's view that core inflation will slide below its 2% target in coming months on easing cost pressure, before resuming a more demand-led increase that justifies additional rate increases.
But some analysts warn of the risk renewed yen declines may prod firms to keep raising prices, leading to sticky, cost-led inflation that could quicken the pace of BOJ rate hikes.
"Today's data suggests food inflation may be peaking. But the weak yen may give firms an excuse to resume price hikes for food, which may keep inflation elevated," said Yoshiki Shinke, senior executive economist at Dai-ichi Life Research Institute.
An inflation index for the capital that strips away both fresh food and fuel costs - closely watched by the BOJ as a measure of demand-driven prices - rose 2.6% in December after a 2.8% increase in November.
Data on Friday also showed Japan's factory output fell 2.6% in November from the previous month, deeper than market forecasts for a 2.0% drop, due to cuts in automobile and lithium-ion battery production.
The BOJ raised its policy rate last week to a 30-year high of 0.75%, taking another landmark step in ending decades of huge monetary support, in a sign of its conviction Japan is progressing toward durably hitting its 2% inflation target.
With core inflation exceeding the BOJ's target for nearly four years, Governor Kazuo Ueda has signaled the BOJ's readiness to keep raising rates if the economy continues to improve, backed by solid wage gains.
Yen bears, however, have dumped the Japanese currency in the belief that Ueda's rate hikes are too gradual, prompting Katayama last week to threaten yen-buying intervention, saying the government was "alarmed as we are clearly seeing one-sided, sharp moves" in the yen.
