BoJ on hold, begins sales of ETF and J-REIT holdings

It also announced the start of sales of its exchange-traded funds (ETF) and Japanese Real Estate Investment Trust, known as Japan REIT, or J-REIT, holdings, albeit at a very gradual pace. The next rate hike is approaching, but we think still high uncertainties around trade and domestic politics mean it will likely be in Q1 2026.

A market surprise followed by a neutral tone

The Bank of Japan (BoJ) held rates unchanged at 0.50% as expected. However, there were a couple of surprises, with the announcement of ETF and J-REIT sales and two board members dissenting in favor of a rate increase to 0.75%. This is a first under Governor Kazuo Ueda’s tenure and signals the internal debate over a hike is intensifying.

Takata Hajime noted that deflation was no longer a concern and price stability had been mostly achieved. Tamura Naoki, seeing increased upside risks to prices, recommended moving the policy rate closer to neutral. They suggested the central bank aims for an overnight call rate of around 0.75 percent.

The BoJ also announced it will begin selling its ¥75 trillion (market value) equity ETF holdings at a pace of ¥620 billion per year and J-REITS at ¥5.5 billion annually. Japanese equities initially sold off in response to the news. However, the sales account for just 0.05% of market trading volume. For context, Ueda noted that, at this pace, it would take over a century to sell all assets.

The BoJ has three principles for the ETF/J-REIT disposal:

1. Dispose holdings for an adequate price, considering the condition of the financial markets
2. Avoid disrupting the market as much as possible
3. Avoid incurring losses

The pace of sales can be modified in future, but we think it is unlikely the BoJ will accelerate it any time soon. So, the disposal decision is likely to have minimal impact on Japanese equities over the medium run.

During the press conference, reporters tried to bait Ueda into laying out the timing of the next rate hike.

When questioned about the two dissenters, Ueda referred to the minutes scheduled for release in November. He refused to comment on the Liberal Democratic Party (LDP)’s leadership contest, fiscal policy, or movements in the yen.

Ueda welcomed the resilience in consumption but reiterated the greater degree of uncertainty than usual around whether the BoJ’s economic projections will materialize. The impact of external risks from trade policy and the slower global growth backdrop were highlighted.

While Ueda avoided commenting directly on domestic politics, uncertainty over the fiscal outlook is probably another factor playing into a further small delay to the ability to hike rates.

Back at the June meeting, Ueda had declined to comment on the political outlook but said that (a) the BoJ will examine the impact of fiscal policy once it has been decided, and (b) the BoJ will resist pressure from a more dovish prime minister and set policy in line with data developments.

The BoJ will also be mindful that the Japanese government bond (JGB) market remains illiquid and highly sensitive to fiscal headlines, although the central bank has the tools to manage bond market dislocation.

Investors also expect rate hikes to be delayed until there is greater political clarity. Overnight indexed swap market has now priced 90% probability of a 25 bps hike in January and 100% in March. October remains a coin flip (Chart 1).

On growth: Early signs of tariff impact materializing

Economic momentum remains strong, with Q2 real GDP growth revised up to 2.2% (SAAR) due to solid consumption, exports and capital expenditure.

However, early indications for Q3 show initial signs of tariff impacts. Auto exports and production declined – a key concern for the BoJ. The weakness came despite automakers responding to tariff announcements by sharply lowering prices to support volumes.

The US-Japan trade agreement reduces some of the major risks, but there remains uncertainty regarding specific details. Tariffs continue to pose an economic challenge that may impact Japan's growth trajectory.

Our forecasts indicate that Japan is likely to avoid recession, but we think economic growth will slow.

On inflation: Supply-side drivers dominate

Ueda continued to argue, correctly in our view, that food price inflation is the primary driver of the headline CPI overshoot, and that underlying inflation pressures are a touch below target-consistent rates. The BoJ's outlook suggests inflation may fall short of the target next year.

August headline CPI slowed sharply from 3.1% year over year to 2.7% year over year. Energy subsidies and fuel price declines were largely responsible. Western core excluding all food and energy was unchanged at 1.6% year over year.

The BoJ will carefully assess the impact of trade policy on wages and the inflation outlook.

Tariffs could affect corporate profits and winter bonuses as well as wage negotiations next spring. This is a critical point that could further delay the next BoJ hike.

While Shuntō spring wage negotiations have delivered record-high wage settlements, these have taken a long time to filter into realized wage growth (Chart 2).

Indeed, there is now a growing debate about the 2026 spring wage negotiations potentially being weaker, in part due to the cumulative rise in wages so far, and in part due to the hit from tariffs.

On politics: Fiscal easing whoever wins

Questions on domestic politics and the impact on fiscal policy were broadly brushed off.

A supplementary budget was originally expected in the autumn, with a budget bill debated in December. However, following the upper house election, the LDP-led coalition lost its majority in both parliamentary chambers, triggering a leadership contest.

An LDP party leadership contest will be held on October 4. The new LDP leader will be confirmed as prime minister by the Diet by mid-October. The front runners are currently:

• Sanae Takaichi, former economic security minister who narrowly lost the last leadership contest to PM Shigeru Ishiba. Known for conservative politics and her past support for fiscal stimulus, including the controversial consumption tax cut
• Shinjiro Koizumi, agriculture minister who gained popularity for stabilising rice prices, and son of former PM Junichiro Koizumi

While Governor Ueda gave his policy speech, LDP leadership candidate Sanae Takaichi held her first campaign press conference. Pledges included:

• Expansionary fiscal policies necessary to boost incomes and improve consumer sentiment
• Measures including raising the limit for untaxed income and eliminating gasoline taxes (last year she had promised scrapping taxes on food)
• No mention of support for a broad consumption tax cut – the influential “Aso faction” is against that and Takaichi will need their support to win the contest
• Plans to strengthen energy security – Takaichi is a proponent of nuclear power and is against importing solar panels
• No comments on BoJ policy – last year she had stated that rate hikes would be “stupid”

Important information

Projections are offered as opinion and are not reflective of potential performance. Projections are not guaranteed and actual events or results may differ materially.

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