Trade in Japanese government bonds (JGBs) was halted following a sharp fall in prices, the first time this has happened in more than a decade.
Yields surged by almost 40 basis points, the biggest-ever one day rise.
The Japanese bond market has been unsettled for several weeks, after the government's decision to finance a pounds 110bn fiscal rescue package by bond sales sparked fears of chronic over-supply in the market.
Yesterday's falls were triggered by Masaru Hayami, the governor of the Bank of Japan, who said the trust fund bureau of the Ministry of Finance, which holds a third of all government bonds, would cease bond purchases in January.
Mr Hayami also hinted that the Bank of Japan, the second largest holder of JGBs, could scale back its activity in the market.
Nick Stamenkovic, chief economist at Bank Austria Creditanstalt Futures, said: "The bubble has burst in the JGB market. Japan's fiscal position is dire. The government has abandoned its committment to reduce its budget deficit, and is pulling out all the stops to turn the economy round."
The sell-off hit the yen, which fell sharply against the dollar, and prompted renewed worries about the health of Japanese banks.
Japanese banks, along with the BoJ and the Ministry of Finance, are the major holders of JGBs.
Bank shares tumbled in Tokyo yesterday on concerns that the banks' exposure to the bond market could undermine further their financial health.
The fall in bank shares dragged the Japanese benchmark Nikkei index down 373.5 points to close at 13,779.45.
The bond market turmoil in Japan spilled over into Europe, where bond prices fell sharply and yields rose.
Mr Stamenkovic said the falls in the European bond markets were simply "a knee jerk reaction" to the difficulties in Japan.Reuse content