The Bank of Japan "unexpectedly turns hawkish": two "opposing votes" and reduction of ETF holdings

Two committee members opposed and unexpectedly announced the sale of ETFs, while Kazuo Ueda "turned hawkish," suggesting that the Bank of Japan may raise interest rates faster than expected.

On Friday, the Bank of Japan released a more hawkish signal than the market expected during its policy meeting. Two members voted against maintaining the current interest rate, and the central bank decided to begin selling its ETF and REIT holdings. This series of actions indicates that the Bank of Japan may exit its monetary easing policy sooner than previously anticipated.

Although the Bank of Japan kept the short-term interest rate unchanged at 0.5%, committee members Hajime Takata and Naoki Tamura proposed raising the rate to 0.75%. Although this proposal was not approved, the market viewed it as a prelude to a rate hike in the near future. This unexpected hawkish stance strengthened the yen, while Japanese stocks retreated from their highs.

The Bank of Japan also announced that it would sell its ETF holdings at a pace of approximately 330 billion yen (2 billion USD) per year and REITs at a pace of approximately 5 billion yen per year. This decision marks the Bank of Japan's continued push towards normalizing monetary policy, although at this pace, it would take over a century to completely liquidate its holdings.

Additionally, Bank of Japan Governor Kazuo Ueda stated after the meeting that if economic and price forecasts are realized, the Bank of Japan will continue to raise interest rates based on improvements in the economy and prices. Market focus has shifted back to the timing of the next rate hike by the Bank of Japan, despite uncertainties in the global outlook and Japanese politics.

Rising Hawkish Pressure Within the Committee

The dissenting votes from the two members highlight the increasing hawkish pressure within the Bank of Japan. Saxo's chief investment strategist Charu Chanana stated:

The dissent from Takata and Tamura underscores the growing hawkish pressure within the Bank of Japan. While the majority of members still prefer a stable path, the dissenting votes indicate that the debate is leaning towards faster normalization.

After a two-day meeting, the Bank of Japan maintained its judgment that the economy will continue to recover moderately but warned that U.S. tariffs are dragging down manufacturers' profits. Ueda emphasized that real interest rates remain very low.

This hawkish turn contrasts sharply with the Federal Reserve's rate cut on Wednesday and its indication of further cuts. Media surveys show that most economists expect the Bank of Japan to raise rates by another 25 basis points before the end of the year, but there is disagreement on the timing, with bets concentrated on October and January next year.

Official Launch of ETF Reduction Plan

The Bank of Japan's decision to sell its ETF and REIT holdings is another step towards normalizing its monetary policy. The central bank accumulated ETF holdings worth 37 trillion yen during its 13-year purchasing program that began in 2010, aimed at revitalizing the sluggish economy.

While the market generally expects the Bank of Japan to eventually reduce its ETF holdings, the announcement came much earlier than the market had predicted. The central bank stated that it would begin selling once necessary operational preparations are completed, possibly starting early next year, and may review the pace of sales at future policy meetings.

The slow pace of sales highlights the Bank of Japan's concern about avoiding excessive market disruption. The decision to reduce ETF holdings pushed the benchmark Nikkei index down from record highs, while the dissent from hawkish committee members drove the yen and short-term bond yields to surge

Increased Political Uncertainty Adds Variables

While some analysts believe that the increase in hawkish dissent has raised the likelihood of an interest rate hike in October, others argue that the political uncertainty triggered by Prime Minister Shigeru Ishiba's decision to resign casts a shadow over such measures.

The ruling party is preparing for a leadership election on October 4 to choose Ishiba's successor. Front-runners include veteran lawmaker Sanae Takaichi, who is a strong opponent of interest rate hikes by the Bank of Japan.

Shinichiro Kobayashi, chief economist at Mitsubishi UFJ Research and Consulting, stated that as the outlook for the U.S. economy slows and the Federal Reserve further cuts rates, it may become increasingly difficult for the Bank of Japan to implement a reverse interest rate hike. The stance of Japan's next prime minister on monetary policy will also be closely monitored following the ruling party's leadership election.

The Bank of Japan exited its massive ten-year stimulus program last year and raised short-term interest rates to 0.5% in January, believing that Japan was on the verge of sustainably achieving its 2% inflation target. Data released on Friday showed that Japan's core consumer prices rose 2.7% year-on-year in August, slowing for the third consecutive month but still above the central bank's 2% target