The governor of Japan's central bank has shrugged off concerns that the recent spike in bond prices could damage the country's fledgling recovery.
Haruhiko Kuroda, the Bank of Japan head, said analysis by the central bank last month showed that the country could withstand an increase in market interest rates of as much as 3 per cent, as long as there were accompanying improvements in the economy.
Japan's sharemarket crashed 7 per cent last Thursday following weak economic data in China, speculation that the US was close to winding up its money-printing program and on fears that falling Japanese government bond prices would undermine the government's economic strategy and punch a hole in bank balance sheets.
Sharemarkets across the world also took fright, with the Australian market down 2 per cent on the day.
But Mr Kuroda said that Bank of Japan estimates in April showed that a 1 to 3 percentage point rise in interest rates would not cause problems for Japan's financial system, as long as it was accompanied by economic improvements, since a recovery would lead to increased lending and help to improve banks' earnings.
"Japan's financial system as a whole seems to possess sufficient resilience against such shocks as a rise in interest rates and deterioration in economic conditions," Mr Kuroda said.
Mr Kuroda and Japan's Prime Minister, Shinzo Abe, have launched a vast stimulus program, promising in April to inject $US1.4 trillion into the economy in less than two years through quantitative easing, to jolt the Japanese economy out of a 15-year deflationary malaise and lift inflation to 2 per cent.
The policy triggered a huge sharemarket rally. But a surge in bond yields, which means bond prices have fallen, has threatened to make government borrowing expensive.
Domestic banks could be forced to take losses on their large holdings of Japanese government debt.
Mr Kuroda said that the Bank of Japan was watching for any signs of overheating in asset prices and would take "appropriate action" if financial imbalances emerge, suggesting it might unwind its ultra-loose policy.
The Nikkei slid another 2.5 per cent on Monday but remains up 36 per cent for the year.