Rising Inflation In Japan: 3 ETFs To Watch As BOJ Navigates Rate Hike Expectations

Japan's core consumer inflation climbed to 3.2% in January, marking its fastest pace in 19 months, according to a Reuters report. As expectations of the Bank of Japan (BOJ) continuing to raise interest rates grow, investors following Japan's economic shifts may want to keep an eye on these three ETFs focused on Japanese equities:

iShares MSCI Japan Index Fund is one of the largest Japan-focused ETFs. EWJ mirrors the MSCI Japan Index, which tracks top Japanese companies across various sectors.

JPMorgan BetaBuilders Japan ETF (BBJP) seeks to track the performance of the Morningstar Japan Target Market Exposure Index. This fund offers a cost-efficient way to invest in Japanese stocks, providing broad exposure to large- and mid-cap companies.

WisdomTree Japan Hedged Equity Fund (DXJ) provides exposure to Japanese equities while hedging against movements in the yen. With a focus on companies that generate a significant portion of their revenue overseas (20% or more, according to DXJ fact sheet), this ETF could benefit from a stronger U.S. dollar.

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Potential Impacts

Japan's core consumer inflation surged to 3.2% in January, marking its fastest pace in 19 months. This rise has fueled expectations that the BOJ may continue raising interest rates from their still-low levels, per Reuters. As inflationary pressures mount, bond yields have also climbed, with the two-year Japanese government bond yield reaching 0.830%, its highest level since October 2008.

If inflation in Japan continues to rise, investors in these ETFs could face mixed outcomes. The BOJ may respond with more aggressive interest rate hikes, increasing borrowing costs for businesses and potentially pressuring stock prices, which could impact ETFs like EWJ and BBJP.

In a note on Jan. 21, Vincent Chung, co-portfolio manager at T. Rowe Price, said that the BOJ’s rate hike may be the first of several gradual increases. He sees the policy rate to likely reach 1% or higher by the end of this year, as reported by CNBC.

Reuters noted that Japan's inflation has remained above the central bank's 2% target for close to three years, putting pressure on policymakers to take further action. The BOJ already raised its short-term interest rate to 0.5% from 0.25% in January in a move to achieve sustainable inflation.

Additionally, a stronger yen due to higher interest rates may hurt export-driven companies, which are majorly large-cap. In this case, ETFs carrying small-cap Japanese stocks, such as the iShares MSCI Japan Small-Cap ETF (SCJ) may be considered. WisdomTree Japan Hedged Equity Fund’s currency-hedged strategy could offer some protection.

On the other hand, one must not forget that external economic developments are also at play. CNBC quoted Chung’s warning that rising U.S. inflation coupled with sustained economic growth later this quarter could lead to a stronger dollar and weaker yen.

Inflation could also mean sector-specific impacts. For instance, while financial and commodity-related stocks can benefit, consumer-driven industries could be strained. Increased market uncertainty and volatility may create short-term fluctuations in these ETFs.

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