Japanese equities fell as the Bank of Japan started its gradual programme to offload its holding of exchange traded funds, though the drop was tempered by the gradual nature of the BOJ unwinding programme.

The BOJ moves comes amid rallying Japanese stocks, with the Nikkei recently hitting record highs.

Japan’s central bank originally started buying ETFs in 2010 in a bid to lower the cost of capital and encourage investment in the corporate sector.

The move is unconventional, in that the BOJ is the only major central bank to inject cash into the economy by acquiring ETFs, a process that critics say risks destroying the market.

The unwinding is designed to be extremely gradual, with the bank suggesting the sell off could take a full century to be completed.

As Nomura Research analyst and a former BOJ Policy Board member Takahide Kiuchi said, “This seems to be more about creating a record of having started normalisation. It does not represent a true exit from large-scale monetary easing.”

Moreover, as Bloomberg notes, a negative impact on equities could potentially halt BOJ’s efforts, as “a weaker stock market risks eroding investor enthusiasm for efforts to normalise Japan’s monetary policy.”

Conversely, two BOJ board members recently voted against the bank’s decision to keep rates steady, a move potentially suggesting a shift to a more hawkish stance.

Economic fundamentals

What about the country’s economic fundamentals? The Japanese economy grew at a faster rate than initial estimates indicated in the second quarter, though headwinds remain.

Uncertainty over wo major areas of concern – political uncertainty and the challenges posed by US tariffs – have started to ease, following the completion of a trade deal with the US and the completion of elections.

Shinjiro Koizumi, who is seen by many analysts as frontrunner to be Japan’s next Prime Minister, has said he would institute policies suitable for tackling inflation and boosting economic growth.

“While being mindful of the need for fiscal discipline, we can use increased tax revenues from inflation to fund policies for achieving economic growth,” Koizumi said.

A Lombard Odier note sees upside for Japanese equities, “amid a solid macro backdrop, positive corporate reforms and earnings”.  In addition, they see a weaker USD and Fed easing during BOJ tightening to lead to “some” medium-term JPY strengthening.

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