BOJ Holds Rates Steady, Surprises with ETF Sell-Off: Is a Rate Hike Looming?

TradingKey - On Friday, the Bank of Japan (BOJ) announced it would keep interest rates unchanged, yet unexpectedly initiated a reduction in its holdings of ETFs (Exchange Traded Funds) and J-REITs (Japanese Real Estate Investment Trusts).

This move triggered a sell-off in Japanese stocks, with the Nikkei 225 index, which had been hovering near record highs, tumbling by as much as 1.76% before closing down 0.57%. Concurrently, the yen strengthened and short-term Japanese bond yields rose.

The BOJ laid out a detailed plan for selling its holdings, aiming to offload ETFs at an annual pace of about ¥330 billion and J-REITs at approximately ¥5 billion per year. According to Reuters, although the market had anticipated the BOJ's ETF reduction, the timing came much sooner than expected.

Analysts suggest that the BOJ is gradually winding down its legacy measures of large-scale stimulus, signaling a move towards further monetary tightening, potentially setting the stage for the next interest rate hike.

Last year, the BOJ exited a decade-long massive stimulus program and raised rates to 0.5% in January, anticipating the achievement of its 2% inflation target. In August, Japan's CPI rose 2.7% year-over-year, well above the central bank's threshold.

In addition to the ETF reduction, another signal warrants attention. During the BOJ policy meeting, two committee members proposed raising rates to 0.75%, indicating an accelerated shift towards monetary policy normalization.

Hirofumi Suzuki, chief forex strategist at Sumitomo Mitsui Banking Corporation in Tokyo, noted that the combined signals point towards an overall hawkish stance. He believes that despite upcoming events like the Liberal Democratic Party elections in October, the BOJ will continue its path to normalization, with expectations of resuming rate hikes in October.

Regarding the future impact on yen-denominated assets, Ben Bennett, head of Asia investment strategy at L&G Asset Management in Hong Kong, stated that the general hawkish tilt, coupled with the Federal Reserve's recent rate cut, could strengthen the yen. This would benefit yen assets but exert pressure on export-oriented companies.

Koike Rihito, a senior economist at Sompo Institute Plus, mentioned that given the limited scale of ETF and J-REIT holdings, the move is unlikely to have a significant long-term impact on Japanese equities.

The BOJ emphasized that the fundamental principles guiding the disposal of these assets are to avoid destabilizing financial markets. Some analysts argue that, at the current pace, it would take the BOJ 112 years to completely divest its ETF holdings. While the sell-off marks an important policy shift, its actual market impact might be limited.