The UK’s Defence Secretary has thrown his weight behind Japanese calls for a dramatic increase in military spending, warning that the current trajectory of global instability demands a fundamental rethink of national security budgets. Speaking at a joint press conference in Tokyo, the minister described Japan’s plan to double defence spending to 2% of GDP by 2027 as ‘critical’ for preserving peace in the Indo-Pacific region.
This is a bold endorsement from a government that has itself struggled to meet NATO’s 2% target, but the logic is clear. The world has changed. With China’s military modernisation accelerating and North Korea’s missile tests becoming routine, the old post-war pacifist consensus in Japan is crumbling. For the markets, this is a double-edged sword.
On one side, defence stocks are rallying. Mitsubishi Heavy Industries and Kawasaki Heavy Industries have seen their shares jump on expectations of long-term procurement contracts. The bond market, however, is less enthusiastic. Japan’s already monstrous national debt, exceeding 260% of GDP, will only grow larger. The Bank of Japan’s yield curve control policy is already under strain; adding a defence spending surge could accelerate the unwanted normalisation of interest rates.
Sceptics will point to the fiscal reality. Japan’s government has been borrowing at negligible rates for years, but that party cannot last forever. The 2% target equates to roughly ¥10 trillion annually, a sum that will almost certainly be funded by additional debt issuance. This threatens to push up long-term borrowing costs, squeezing the economy further.
But the Defence Secretary’s point is that peace has a price, and the alternative is far costlier. The UK knows this from its own experience. The British defence budget has been a political football for decades, with promises of increases often undermined by Treasury penny-pinching. The difference now is that the threat is real and immediate.
For investors, the defence surge is a signal to overweight Japanese equities, particularly in the defence and cyber security sectors. But caution is warranted. The fiscal drag from higher interest payments could weigh on the broader economy. The Bank of Japan will be forced to walk a tightrope, balancing the need to contain inflation with the risk of triggering a bond market sell-off.
Ultimately, this is not just a defence story. It is a story about the end of the era of cheap money and the return of fiscal discipline. Japan’s choice to rearm is a bet that the economic benefits of stability will outweigh the costs. The market will be the judge. And as always, the market has a short memory for goodwill and a long memory for debt.
