Japan — long the epitome of chronic deflation and weak growth — is behaving like a country that has emerged from a malaise once considered incurable. Deflation appears consigned to the past, the output gap has closed, and pricing power has returned to sectors that have not known it for decades. “This is a structural transformation of Japan,” says Keiichiro Kobayashi, an economist at Keio University, describing a shift from a demand‑shortage to a supply‑shortage economy.

Yet the public debt pile exceeds 200 % of GDP. Bond yields are converging with those of other rich nations; the spread between US and Japanese 10‑year yields has fallen from nearly 400 bps in 2023 to under 200 bps today. Prime Minister Sanae Takaichi’s cabinet approved a plan to mobilise $2.3tn in public and private spending through 2040, aiming to more than double structural growth. Meanwhile the yen has sunk below ¥163 to the dollar, its weakest level in over 40 years.

The Bank of Japan, still engaged in QE, raised its overnight rate to 1 per cent in June and promises “nimble responses” to rising long‑term rates. The government spent $72bn in spring to curb yen depreciation, with only modest effect. Japan’s massive domestic bond holdings and a net international investment position of $3.5tn provide buffers, but higher rates and FX sales risk exporting pressure to other sovereign bond markets, raising the spectre of contagion.