German Bond Yields Face Weekly Spike After Japan Rout

Germany is facing a severe electricity crisis marked by shortages and soaring costs, and the situation is getting worse. In a frank admission, German Chancellor Friedrich Merz has called the country's decision to shut down its nuclear power plants a "severe strategic mistake."

German Chancellor Friedrich Merz has criticized the country's move away from nuclear power, citing unsustainable costs.

The High Cost of an Ambitious Energy Transition

According to Merz, the only way to achieve acceptable market prices for energy is through ongoing government intervention. "We would have to permanently subsidize energy prices from the federal budget," he stated, before adding a critical reality check: "We can't do this in the long run."

With pronounced frustration, Merz described Germany’s current path as "the most expensive energy transition in the entire world." He lamented the unique difficulty of his country's self-imposed energy challenge, stating, "I know of no other country that makes things so expensive and difficult as Germany."

A Pivot to Gas to Fill the Power Gap

To address the energy shortfall, Merz's government is turning to fossil fuels. It plans to solicit bids this year to build 8 gigawatts of new gas-fired power plants, with a target of bringing them online by 2031.

An additional 4 gigawatts of capacity is also planned, intended to come from lower-carbon energy sources or from gas plants that can be quickly converted to run on hydrogen. Merz also noted that for industrial power prices, "the European Commission will also approve the combination of several options."

Broader Economic Risks for Europe

Germany's energy problems have significant implications beyond its borders. As the largest economy in the European Union, its industrial sector forms the backbone of the entire European economic model.

When combined with other mounting pressures, this internal energy struggle paints a tenuous picture for Europe's economic future. Key challenges include:

• A new trade relationship with the USA.

• Increasingly cheap goods from China being dumped into the EU market.

• The EU's continued financial commitment to the war effort in Ukraine against Russia.

Prime Minister Sanae Takaichi’s call for a snap general election on February 8 has sent tremors through Japan’s financial markets. Her decision to seek a public mandate for her reflationist economic policies has pushed bond yields to multi-decade highs, signaling rising anxiety over the country’s strained finances.

With voters heading to the polls, each political party is presenting a distinct vision for Japan's economy. Here’s a clear breakdown of the key economic policies on the table.

LDP: Takaichi's High-Stakes Bet on Spending

The ruling Liberal Democratic Party (LDP), led by Prime Minister Takaichi, is campaigning on a platform of more aggressive government spending. Since succeeding her predecessor Shigeru Ishiba, Takaichi has worked to relax Japan's traditionally strict fiscal targets.

While she recently acknowledged the Bank of Japan's December interest rate hike, which aimed to curb the yen's slide, an election victory could empower her advisors to push back against further rate increases that might slow economic growth.

Takaichi has promised to end what she calls "excessively" tight fiscal policy. A core pledge is to suspend the 8% sales tax on food for two years. She has ruled out issuing more government debt to fund this but remains vague on how the revenue gap will be filled, stating it will be decided after negotiations with other parties.

Critics argue these policies could fuel already-rising inflation while failing to solve deeper economic problems like labor shortages and supply-chain constraints. The LDP's draft manifesto insists Japan can achieve both a strong economy and sustainable fiscal policy to maintain market trust in the yen, aiming to lower the nation's debt-to-GDP ratio.

Japan Innovation Party (Ishin): The LDP's Key Ally

The right-wing Japan Innovation Party (Ishin) helped Takaichi secure the premiership in October and now forms a ruling coalition with the LDP.

While the party traditionally advocates for deregulation and cutting wasteful spending, it has aligned with the LDP on a key tax issue. As part of their coalition agreement, Ishin supports suspending the 8% food sales tax for two years and agrees that the measure should be funded without issuing additional debt.

Centrist Reform Alliance: A Permanent Tax Cut Proposal

A new force in opposition, the Centrist Reform Alliance (CRA) was formed between the Constitutional Democratic Party of Japan and Komeito. The alliance positions itself as a middle-ground alternative on economic policy.

The CRA’s flagship proposal is to permanently abolish the 8% consumption tax on food. To make up for the lost revenue, the party suggests creating a sovereign wealth fund to generate profits by investing government reserves more effectively. The alliance also aims to correct the "excessive" weakness of the yen that is driving up inflation, with a focus on lowering prices for essentials like food and fuel.

Democratic Party for the People (DPP): Targeted Spending

Led by former finance ministry official Yuichiro Tamaki, the DPP is focused on boosting household purchasing power, primarily through tax exemptions.

The party proposes a significant investment in the future, calling for the issuance of 5 trillion yen ($31.62 billion) in "education" bonds each year. This funding would be used to double spending on child care, education, and scientific research.

In an interview, Tamaki expressed a cautious view on broad tax cuts, arguing that the consumption tax should only be reduced if the economy falters due to weak demand. He believes it is not a fast enough tool to provide immediate relief from rising living costs. On monetary policy, he said the Bank of Japan should continue raising interest rates, provided that small and medium-sized firms can sustain wage hikes of around 5%.

Sanseito: A Radical Call to Axe the Consumption Tax

Once a fringe political group, the far-right Sanseito party gained significant ground in the upper house election last July with its "Japan First" campaign.

The party’s economic platform is its most radical. Sanseito calls for abandoning the consumption tax altogether and completely overhauling what it sees as overly restrictive fiscal policy by dramatically ramping up government spending.

Inflation Edges Up, But Big Picture Looks Different

South Africa’s inflation rate saw a minor increase in December, but this is unlikely to derail a potential interest rate cut by the central bank later this month. The key reason is that average price growth for 2025 undershot the bank's own projections, and underlying inflationary pressures continue to weaken.

Statistics South Africa reported on Wednesday that annual consumer prices rose by 3.6% in December, a slight acceleration from November's 3.5% figure. This matched the median forecast from a Bloomberg survey of 17 economists.

More importantly, the average inflation rate for the full year of 2025 came in at 3.2%. This is lower than the central bank's forecast of 3.3%, signaling that the broader price trend remains under control.

Factors Supporting a Sooner-Than-Expected Cut

The lower-than-expected annual average, combined with several favorable economic factors, strengthens the case for the monetary policy committee to lower borrowing costs at its January 29 meeting. These factors include:

• Softer oil prices

• A stronger rand relative to the U.S. dollar

• Record-low inflation expectations among the public and investors

These developments give policymakers more room to consider easing monetary policy to support the economy.

Central Bank Sets Sights on New 3% Target

The central bank is now operating with a new, formal inflation target of 3%, a goal officially adopted by the National Treasury in November. This new framework is central to its forward-looking policy decisions.

Speaking from the World Economic Forum in Davos, Governor Lesetja Kganyago indicated that inflation is expected to remain contained. "Throughout the year," he said in a Bloomberg TV interview, "the inflation prints that we expect for each one of the months is that they will all have a 3% handle."

Kganyago clarified that any decision to cut interest rates will depend on the inflation outlook. He projects that inflation in the current year will "average anything around 3.5%." By 2027, he expects it to converge toward the new 3% target, which he said means "we still have room" to ease policy.

UK inflation unexpectedly climbed in December, reaching 3.4% and slightly complicating the outlook for the Bank of England. The figure surpassed both the 3.2% recorded in November and the 3.3% median forecast from economists.

Despite the increase, which keeps Britain's inflation the highest among G7 nations, investors largely held their ground, maintaining expectations for interest rate cuts later this year. Markets showed little reaction, as key indicators watched by the central bank, such as services price inflation, moved in line with predictions.

Bank of England Governor Andrew Bailey has signaled that inflation is on track to approach the 2% target in the coming months.

What Drove the Price Increase?

The Office for National Statistics reported that the primary drivers behind the December inflation rise were increased costs for tobacco and air travel. The uptick was largely attributed to a government duty increase on tobacco products and seasonal flight pricing around the Christmas period.

Services inflation, a metric closely monitored by the Bank of England for underlying price pressures, rose from 4.4% to 4.5%, matching economists' expectations.

Bank of England's Stance and Market Outlook

The latest figures are unlikely to alarm policymakers at the Bank of England. Economists noted that the data aligned closely enough with the central bank's projections from November. Adam Deasy, an economist at PwC, described the increase as a "speed-bump, rather than an indication we are veering off course on the road to price stability."

Financial markets continue to price in at least one quarter-point interest rate cut in 2026, with some anticipating two. This outlook persists even though the Monetary Policy Committee was divided at its last meeting, where it cut the Bank Rate to 3.75%, with nearly half its members favoring no change due to inflation concerns.

Nicholas Crittenden of the National Institute of Economic and Social Research think tank stated, "The Bank of England will ... not be worried by these numbers." He added, "We still predict one cut in Bank Rate in the first half of this year, provided renewed geopolitical tensions do not blow the current path of inflation off course."

Why Analysts Expect Inflation to Cool

Despite the December uptick, the broader consensus is that inflation will slow significantly in the coming months. Bank of England Governor Andrew Bailey has previously stated that inflation is likely to return to the central bank's 2% target around April or May.

This expected decline is largely due to base effects, as the sharp rises in utility costs and other government-regulated tariffs from the previous year will no longer be part of the annual comparison.

Further data on producer prices showed that while costs in the services sector rose to 2.9% in the fourth quarter from 2.0% in the third, prices from manufacturing firms remained stable in December, suggesting a mixed but not universally inflationary business environment.

China's latest auction of seven-year government bonds saw exceptionally strong demand on Wednesday, signaling growing investor appetite for the nation's debt even as global markets experience volatility.

Record-Breaking Auction Highlights Investor Confidence

The auction's bid-to-cover ratio, a key measure of demand, surged to 5.91. According to Bloomberg data, this figure represents a record high for China's seven-year government debt offerings.

This overwhelming interest underscores the increasing perception of Chinese sovereign debt as a reliable hedge against international instability.

A Haven in a World of Market Volatility

Investors are turning to Chinese bonds due to their low correlation with turbulent external markets. The robust demand comes at a time of heightened global uncertainty, driven by several key factors:

• The United States is threatening tariffs against European nations over Greenland.

• Japanese government bonds have recently experienced a slump.

In this environment, the stability offered by Chinese sovereign debt has become a significant draw for capital.

Abundant Domestic Cash Fuels Bond Demand

The demand for China's sovereign bonds is not just an international story. It is also heavily supported by rich liquidity within China's domestic financial system, which particularly benefits shorter-tenor debt.

Cash has been plentiful in the onshore market, keeping funding costs at relatively low levels. Last month, the overnight repo rate fell to its lowest point since 2023 and has remained subdued, creating favorable conditions for bond investment.

Analyst View: Attractive Value vs. Yield Curve Trends

Jeffrey Zhang, an emerging markets strategist at Credit Agricole CIB, noted that the auction results suggest a positive shift in market dynamics. "This could suggest that supply-demand dynamics have started to turn favorable, as dip-buyers began to see attractive value" in certain parts of the yield curve, he said.

However, Zhang cautioned that a broader trend reversal is not yet confirmed. "We haven't noticed clear fundamental catalysts to reverse the steepening trend of the yield curve at this moment," he added.

Post-Auction Yields Drop to Monthly Low

Following the successful auction, the yield on the seven-year bond in the secondary market fell by one basis point to 1.69%. This marked the lowest yield for the bond so far this month, reflecting the immediate market impact of the strong investor demand.

The European Union's landmark trade deal with the Mercosur bloc is already facing a critical test, with lawmakers set to vote on a legal challenge that could delay the agreement for at least two years and possibly derail it entirely.

Signed just last Saturday, the pact with South American nations Argentina, Brazil, Paraguay, and Uruguay is the EU's largest-ever trade agreement. However, it requires final approval before it can be implemented, and a significant faction within the European Parliament is moving to halt its progress.

The Legal Gambit to Stall the Agreement

A coalition of 144 lawmakers has formally requested that the EU's top court, the European Court of Justice, review the agreement's legality. Their challenge is built on two key questions:

1. Can the trade deal be applied provisionally before it is fully ratified by all individual EU member states?

2. Do the agreement's terms illegally restrict the EU's authority to establish its own environmental and consumer health policies?

A referral to the court would trigger a lengthy review process, which typically takes around two years to conclude. This delay introduces significant uncertainty for a deal that has already been 25 years in the making.

A Deal Divided: Farmer Protests vs. Geopolitical Strategy

Opposition is fierce, led by France, the EU's agricultural heavyweight. Critics warn the pact will open the floodgates to inexpensive beef, sugar, and poultry from South America, undercutting domestic producers. European farmers have staged repeated demonstrations, arguing the deal poses a direct threat to their livelihoods.

Figure 1: French farmers from unions like FNSEA and Jeunes Agriculteurs protest the EU-Mercosur agreement, arguing it threatens European agriculture and food security.

On the other side, supporters like Germany and Spain see the agreement as a crucial strategic move. They argue it is essential for offsetting business lost to U.S. tariffs under President Donald Trump and for reducing economic reliance on China by securing access to critical minerals from South America. Proponents also warn that the Mercosur governments are growing impatient after decades of negotiations.

What's Next for the EU-Mercosur Pact?

The vote on whether to proceed with the legal challenge is scheduled for 1130 GMT on Wednesday.

Even if the matter is sent to the court, the EU could theoretically apply the pact on a provisional basis while awaiting the ruling. However, this would be a politically difficult step given the intense backlash. Furthermore, the European Parliament would ultimately retain the power to annul the agreement at a later stage, leaving its long-term future in doubt.