Japan acts to avert ETF market liquidity squeeze
The Bank of Japan has launched an unusual lending facility for exchange traded funds as it tries to mitigate the market impact of its ultra-aggressive monetary policy.
Under the new facility, brokers will be able to borrow some of the central bank’s ¥28tn ($256bn) holdings in equity ETFs for up to a year, at interest rates to be determined by auction.
The new facility, first announced in April, is intended to boost liquidity in a Japanese ETF sector dominated by the central bank, which owns two-thirds of the total outstanding stock and has come under fire for allegedly distorting the market.
It highlights the BoJ’s concern about the sustainability of its monetary policy in the seventh consecutive year of large-scale asset purchases under governor Haruhiko Kuroda, aimed at reducing interest rates and ending years of on-and-off deflation.
In contrast to other central banks, the BoJ has bought equities in the form of ETFs as well as government bonds. In theory, by reducing the supply of assets available to private investors, such purchases will drive down the cost of capital, spurring investment and activity in the economy.
However, the BoJ has struggled to get inflation to its 2 per cent target despite years of stimulus, and ETFs have been piling up on its balance sheet. Recently, the central bank has focused on reducing any negative side effects on the financial sector rather than easing monetary policy further.
Similar to central bank repurchase agreements for government bonds, the ETF lending facility should reduce spreads between bid and ask prices by making it easier to settle trades. It may also provide an attractive way to short the Japanese market, allowing traders to sell borrowed ETFs and buy them back at a later date.
The decision came at the BoJ’s final monetary policy meeting of the year, where it kept monetary policy on hold, with short-term interest rates at minus 0.1 per cent and a cap on 10-year bond yields at about 0 per cent.
“Japan’s economy is likely to continue on a moderate expanding trend, as the impact of the slowdown in overseas economies on domestic demand is expected to be limited,” said the BoJ in a policy statement.
It said industrial production had fallen but blamed it on natural disasters, while risks coming from overseas are “significant” but no longer “increasing”.
The central bank voted 7-2 for the policy decision, with the dissent coming from policymakers who wanted a more stimulative policy. Most economists now expect rates to stay on hold for the foreseeable future.