TOKYO: The yield on benchmark Japanese government bonds (JGBs) is challenging the 2% threshold that has acted as a ceiling for a quarter of a century, signalling for markets the country’s long-awaited emergence from deflation, analysts and investors say. The 10-year JGB yield climbed almost 30 basis points in a month to reach an 18-year high of 1.97% on December 8 and continues to hover just below that level. Bond yields have been lifted by expectations that the Bank of Japan will restart its monetary tightening campaign this week, as well as worries about a rush of issuance to pay for the new government’s 21.3 trillion yen ($136.9 billion) stimulus package, the largest since the pandemic. A simultaneous rate-hike cycle and fiscal largesse would generally be considered a broad policy contradiction, but in Japan’s case it underscores the current struggle with rising prices of food and energy. It’s a predicament unfamiliar to a generation that experienced seven consecutive years of deflation from 1999, and barely any recovery in the years that followed, even with massive monetary and fiscal stimulus from 2013 under late Prime Minister Shinzo Abe’s “Abenomics” programme. “A 10-year bond yield of 2-3% is highly symbolic, and very positive for corporate activity,” said Yuichi Chiguchi, chief investment strategist at BlackRock Japan. “After experiencing deflation for three decades, we’re now transitioning to a reflationary environment.” Economists polled by Reuters expect data due Friday to show core inflation continued to run at a 3% annual pace in November, far exceeding the Bank of Japan’s 2% target. Sentiment among big manufacturers hit a four-year high in the central bank’s closely watched quarterly “tankan” survey, released on Monday. BlackRock’s Chiguchi says 2% will soon become the floor for the 10-year yield, predicting a climb towards 3%. It stood at 1.945% on Monday. In the years following the bursting of Japan’s “bubble” economy in the 1990s, the 10-year JGB sank below 2% in 1999 and never resurfaced, barring a brief blip to 2.005% on May 10, 2006. While it may seem hard for the current generation of debt traders to imagine a world of 2% yields, Chiguchi said, he recalled hearing the same thing in reverse as a bond fund manager in 1997. “My seniors kept saying, ‘It’s impossible for the 10-year JGB yield to fall below 2.5%.’ They said, ‘This can’t be happening, it doesn’t make sense.’“ For many of today’s traders, the defining period has been the seven-plus years from 2016 when the 10-year yield was pinned near zero by a policy known as yield curve control, part of a massive monetary stimulus programme under then-BOJ Governor Haruhiko Kuroda. Current Governor Kazuo Ueda ended the policy early last year when embarking on the current tightening cycle, but rate hikes have been halting, mainly due to an abundance of caution over the potential fallout from aggressive US trade tariffs. A hawkish shift in rhetoric from Ueda at the beginning of this month, however, sent traders rushing to price in the near certainty of a quarter-point rise in the short-term policy rate to 0.75% from 0.5% on Friday. The central bank will likely be pleased to see 10-year yields at the current level, said Shoki Omori, chief desk strategist at Mizuho Securities, “because it suggests that inflation in Japan is going to be stable around 2% over the next decade.” Fiscal rather than monetary policy is likely to be the bigger driver of yield direction, Omori said, predicting that funding government stimulus will almost certainly require additional 10-year note issuance along with increased supply of shorter-dated debt. Rises in JGB yields accelerated last month on heightened speculation about the size and shape of the government’s spending package. Yields on the longest-dated debt surged to record peaks as investors demanded a higher premium to hold the bonds of the most-indebted developed nation. “The move in the past couple of weeks has been pretty rapid, faster than we expected but in terms of the level, we’re not surprised,” said Shusuke Yamada, chief Japan foreign exchange and rates strategist at Bank of America, who sees a rise above 2% for the 10-year yield as a given over coming weeks and months. “It symbolizes a normalization from deflation,” he said. “Unlike in the early 2000s, 2% is not a magic number.”