Japan election raises odds of sales tax cut, bond yields jump

Likelihood of Consumption Tax Cut

Japan's looming snap election has significantly increased the chances for a temporary cut in consumption tax aimed at alleviating the cost-of-living burden on households. Both the ruling Liberal Democratic Party (LDP) and opposition politicians are signaling support for easing taxes on food, unsettling the bond markets. LDP leaders have expressed intentions to aim for a two-year suspension of the 8% consumption tax on food, reflecting growing political pressure ahead of the potential February election. Japan currently applies an 8% sales tax on food and a 10% rate on other goods and services, which is crucial for funding social welfare in an ageing society.

Bond Market Reaction

Concerns over Japan's fiscal trajectory have intensified as the yield on 10-year Japanese government bonds climbed to 2.215%, its highest since 1999. This rise reflects fears that the tax cuts may be financed by additional debt issuance, rattling bond investors amidst heightened market anxieties.

Inflation Pressures

With inflation exceeding the Bank of Japan's 2% target for nearly four years, largely driven by persistently high food prices, the arguments for tax relief are gaining traction. However, the scrapping of the food tax could cost approximately 5 trillion yen ($31.7 billion) annually, raising concerns over Japan's strained public finances and the risk of a sustained bond market sell-off.