TOKYO - Japan has experienced sustained inflation since 2022. In its April economic outlook report, the Bank of Japan projected 2.8 percent inflation in fiscal 2026. Nevertheless, the policy rate remains at 1 percent, even after an increase in June. Among major economies, it is unusual for the rate to continue to fall so far below inflation. If the BOJ delays rate hikes due to excessive concern for the economy, it may respond too late, which could hit households through faster increases in living costs.
Meanwhile, long-term yields on Japanese government bonds have already risen in the market, where investors around the world repeatedly trade. The yield on 10-year bonds has reached the upper 2 percent range and on 30-year bonds, near 4 percent. A large gap has emerged between the BOJ's policy rate, which guides short-term rates, and market-determined long-term rates.
In theory, higher interest rates should make it harder for companies to raise funds, which would weigh on the economy. So why are stock prices rising to unprecedented levels? This is due to a structural change that Japanese companies have undergone over several decades.
In a "world with interest rates" that existed before and during the asset-inflated Japanese bubble economy, companies that borrowed from banks for capital investment were chronically short of funds. During that era, rising rates directly increased interest expenses and squeezed earnings. This is why rate hikes affected stock prices.
But after several decades, Japan's corporate landscape has changed dramatically as it looks to normalize interest rate policy. Amid prolonged deflation and slow growth, Japanese firms paid down debt and transformed into entities with ample cash reserves. With some exceptions, many major companies now have ample internal funds. Even if rates rise, interest expense is less likely to become a heavy burden, and belated increases in the policy rate will not restrict the procurement of working capital.
Furthermore, short-term rates remain well below the rate of inflation, and increased sales due to price hikes can offset the impact. This historic shift from cash shortages to surpluses is the main reason rate hikes have had a diluted impact on the stock market.
Nevertheless, a change has occurred since the beginning of 2026 that cannot be overlooked. Stock dividend yields, once a key attraction, have begun falling below the yield on 10-year government bonds. Consequently, in the stock market, shares of companies favored by investors focused on future earnings expectations rather than near-term dividends are driving the overall rise, and polarization is becoming more pronounced.
Although companies have become less vulnerable to rising interest rates, dividends have become less attractive to investors. Therefore, stock prices are becoming overly dependent on future earnings growth.
Now is the time to rethink asset management. If inflation continues at a rate of 2 to 3 percent each year, investors will need returns above that level to prevent their assets from shrinking in real terms. With gradual rate hikes, it will be difficult for interest rates on deposits to exceed that level. Going forward, the challenge will be to secure investment gains that outpace inflation by combining options such as government bonds, whose yields have risen sharply, and stocks of companies expected to grow steadily, even in unstable times.
(Kenichi Hirayama, born in 1966, has served as a professor at Reitaku University since April 2025. He completed graduate studies at Saitama University, earning a Ph.D. in economics and became chief investment officer at Tokio Marine Asset Management Co. His specialties are financial theory and the history of financial markets.)
