Japan’s FY26 budget to top ¥122 trillion as spending outpaces inflation

Japan will be introducing its biggest-ever budget for the fiscal year starting April 2026, with Prime Minister Takaichi Sanae confirming the total will hit ¥122.3 trillion, which is a 6.3% increase from 2025’s ¥115.2 trillion.

To fund it, Takaichi said the government plans to raise ¥29.6 trillion by selling new bonds. Even with that figure, debt financing will slightly decrease, making up 24.2% of the budget compared to 24.9% in the current fiscal year.

“I believe this budget strikes a balance between strengthening the economy and ensuring fiscal sustainability,” Takaichi-san said after meeting with ruling party officials and cabinet members.

This is a big deal because Japan holds the heaviest debt burden on earth, so global investors are uneasy with the prime minister’s spending style. Longer-term bond yields have already been creeping up this year, and a blowout budget only adds to the pressure.

Koji Takeuchi, a senior research fellow at Itochu Research Institute, said the size of the budget is a red flag.

“The size of the initial budget is a record, which is negative for yields,” Koji said. “At the same time however, government bond issuance has been kept in check,” he added, pointing out that long-term bond supply won’t rise and mid- to long-range issuance may even shrink.

Spending increase driven by inflation, social needs, and defense

This record budget comes while costs continue rising across Japan, because inflation remains above 2% for more than three years. Prices on essentials are still surging, yet a big chunk of the increased budget is going toward social security, which will rise from ¥38.3 trillion to ¥39.1 trillion.

That bump is tied directly to Japan’s aging population and the growing demand for elderly care and support services, according to the Takaichi cabinet.

Takaichi is also prioritizing defense spending. With geopolitical tensions in the region and pressure on national security, those costs are going up too. Her team sees this as part of the same demographic and global reality fueling the rest of the budget increase.

Last month, her administration launched what officials say is the largest economic package since COVID-19 restrictions were lifted, meant to ease the pressure from higher prices and help fund military upgrades.

Despite pushing expansionary policies, Takaichi keeps repeating that she’s being responsible. Finance Minister Satsuki Katayama admitted earlier this week that the plan could hurt fiscal health in the short term, but said it’s needed to push for future growth.

Markets so far haven’t reacted much to the budget news. But the government’s borrowing costs are getting heavier. The Finance Ministry will use a 3% interest rate for debt servicing in FY26. That’s the highest level since 1997, based on what Bloomberg learned from officials.

BOJ eyes more hikes as revenues and real rates move

Takaichi expects to collect ¥83.7 trillion in tax revenue next year, which helps offset borrowing needs. Koji said this is one reason markets haven’t overreacted.

“Tax revenues have been fairly solid, which likely helped Takaichi with addressing market concerns,” he said. But he warned the government needs to find better ways to secure cash if it plans to cut down bond sales in the future.

Meanwhile, Bank of Japan Governor Ueda Kazuo gave his final speech of the year Thursday, saying there’s growing confidence the central bank will hit its 2% inflation goal. “The achievement of the 2% price stability target, accompanied by wage increases, is steadily approaching,” Ueda said at a Keidanren-hosted business event on Christmas.

Ueda’s comments came just days after the BOJ raised borrowing costs to the highest level since 1995. Traders are already betting on more hikes. Ueda didn’t give a date but made it clear the bank will raise rates again if the economy stays on track.

He pointed out that real interest rates are still low, and most watchers expect one hike every six months starting next year.

“It is highly likely that the mechanism in which both wages and prices rise moderately will be maintained next year and beyond,” Ueda said. “As a result, it appears that the likelihood of realizing the bank’s baseline scenario has been rising.”

If you’re reading this, you’re already ahead. Stay there with our newsletter.