For decades, Japan was the world’s great economic puzzle: rich, but stuck with falling prices and near-zero interest rates. That’s changing. Here’s what’s happening, and why markets watch it so closely.
Japan has one of the world’s largest economies, and it’s Australia’s second-biggest trading partner after China, buying large amounts of Australian coal, gas, beef and iron ore. Japanese companies are also major investors in Australia.
The lost decades
In the late 1980s, Japan experienced a huge bubble in share and property prices. When it burst around 1990, share prices crashed, property values fell for years and banks were left with large bad debts.
What followed became known as the “lost decades”: years of slow growth and, at times, deflation, where prices fall. Deflation can be damaging, because people delay spending if they expect things to get cheaper, and debts become harder to repay.
The Nikkei 225 share index didn’t regain its 1989 peak until 2024, almost 35 years later.
The Bank of Japan
To fight deflation, the Bank of Japan, the country’s central bank, cut interest rates to zero and below, and bought huge amounts of government bonds and even shares to pump money into the economy.
In 2024, with inflation finally rising, it ended its negative interest rate policy, its first rate rise in 17 years. It has continued raising rates gradually since, lifting its key rate to around 1% in June 2026, as higher wages and energy costs pushed up prices.
The yen
Because Japanese interest rates were so low for so long, investors often borrowed in yen and invested in higher-yielding assets overseas, a strategy known as the “carry trade”. That helped keep the yen weak.
When Japanese rates rise or the yen strengthens suddenly, investors can rush to unwind those trades, which can cause sharp falls in global markets, as happened briefly in August 2024.
A weak yen makes Japanese exports cheaper and is popular with tourists, including many Australians, but it pushes up the cost of imports such as food and energy for Japanese households.
Debt and ageing
Japan has the highest government debt of any major economy, at well over 200% of its economic output. Most of it is owned by Japanese investors and the Bank of Japan, which has helped keep borrowing costs low.
It’s also one of the oldest societies in the world, with a shrinking population, which limits growth and puts pressure on its workforce and pension system.
How Japan manages rising interest rates with such high debt is closely watched by investors around the world.
