BOJ to unwind ETF holdings as split board signals hawkish shift

By Leika Kihara and Makiko Yamazaki

TOKYO (Reuters) - The Bank of Japan decided on Friday to start selling its holdings of risky assets and two board members voted against keeping interest rates steady, suggesting the bank would phase out its massive monetary stimulus sooner than first thought.

While the central bank kept short-term interest rates at 0.5%, board members Hajime Takata and Naoki Tamura proposed, unsuccessfully, a hike to 0.75% in a move markets saw as a prelude to a near-term increase in borrowing costs.

"The dissent from Takata and Tamura highlights growing hawkish pressure inside the BOJ," said Charu Chanana, Chief Investment Strategist at Saxo.

"While the majority still favour a steady path, the presence of two board members voting against today's decision suggests the debate is tilting toward quicker normalisation."

The hawkish shift surprised markets and led some market players to bet on a rate hike next month, even as uncertainty over the global outlook and domestic politics grows.

"It seems that momentum towards a rate hike is building within the board more than expected," said Atsushi Takeda, chief economist at Itochu Economic Research Institute. "We can say the chance of an October rate hike has heightened."

At the two-day meeting that ended on Friday, the BOJ decided to sell its holdings of exchange-traded funds (ETF) in the market at an annual pace of around 330 billion yen ($2 billion).

It also decided to sell real-estate investment trusts (REIT) at an annual pace of around 5 billion yen.

The BOJ said it would start selling once necessary operational preparations are completed, and could review the pace of selling in future policy meetings.

The decision marks another step toward dismantling remnants of the BOJ's radical stimulus aimed at reviving a moribund economy, which left it with 37-trillion-yen worth of ETFs on its balance sheet accumulated during 13 years of purchases.

But the slow pace of selling, which will likely start early next year, means it would take more than a century to unload all of its holdings, underscoring the BOJ's focus on avoiding any undue market disruptions.

While the BOJ was widely expected to unwind its ETF holdings eventually, the announcement came much sooner than the market was predicting.

The decision to unload ETFs pushed down the benchmark Nikkei index from its record high, while the yen and short-term bond yields surged on the hawkish board dissent.

The BOJ's hawkish tilt contrasted with the U.S. Federal Reserve's decision on Wednesday to cut interest rates and signal more reductions to halt any slide in an already weakening labour market.

POLITICAL HEADWINDS?

The BOJ maintained its view the economy would continue to recover moderately, but warned that U.S. tariffs were weighing on manufacturers' profits.

Governor Kazuo Ueda said he preferred to scrutinise more data for clues on how U.S. tariffs could affect Japan's economy - remarks seen by markets as leaving the BOJ a free hand on the timing of the next rate hike.

"So far, we're not seeing a major impact from U.S. tariffs on Japan's economy," he told a news conference. "But we need to be mindful of downside economic and price risks, as the impact from U.S. tariffs will start to intensify."

The BOJ's rate-hike path is also complicated by political uncertainty caused by Prime Minister Shigeru Ishiba's decision to step down, announced this month.

The ruling party is gearing up for a leadership race on October 4 to choose Ishiba's successor, which precedes the BOJ's policy meeting on October 29-30. Among frontrunners is veteran lawmaker Sanae Takaichi, a vocal opponent of BOJ rate hikes.

"With the prospect of a slowdown in the U.S. economy and further rate cuts (by the Fed) on their way, it may become increasingly difficult for the BOJ to move in the opposite direction and raise interest rates," said Shinichiro Kobayashi, principal economist at Mitsubishi UFJ Research and Consulting.

"The stance of Japan's next prime minister on monetary policy following the ruling party's leadership race will also be closely watched."

A Reuters poll showed a majority of economists expect another 25-basis-point hike by year-end. But those surveyed are split on the timing with bets centering on October and January.

The BOJ exited a massive, decade-long stimulus programme last year and raised short-term rates to 0.5% in January on the view Japan was on the cusp of sustainably achieving its 2% inflation target.

While Ueda signaled the BOJ's resolve to keep raising rates, he said the bank decided to hold rates steady because underlying inflation remained short of its target.

Takata dissented on the view the BOJ's price target has already been achieved, while Tamura did so on grounds that inflationary risks were building.

Japan's core consumer prices rose 2.7% in the year to August, data showed on Friday, slowing for the third straight month but staying above the central bank's 2% target.

($1 = 147.7300 yen)

(Reporting by Leika Kihara; Additional reporting by Makiko Yamazaki, Satoshi Sugiyama, Kantaro Komiya and Chang-Ran Kim in Tokyo and Ankur Bannerjee in Singapore; Editing by Sam Holmes)