Japanese Yen Strengthens as BOJ Expected to Hike Rates Again, EUR/JPY in Focus

Whilst most major central banks in developed economies are looking to continue cutting rates, the Bank of Japan may hike rates again when they meet in December. The playing field is very different as Japan has struggled with low inflation for a decade, even during the post-covid economic recovery. During this time, headline inflation remained below 5% in Japan, when the US, Europe and UK were seeing CPI figures closer to 10%. As a response, a strict rate hiking cycle ensued in most developed economies, but the Bank of Japan (BoJ) left rates unchanged at -0.1% throughout.

This led to a continued depreciation in the Japanese yen as the rate differential meant that borrowing in yen and using them to buy other currencies was highly lucrative. As a result, the yen saw continued depreciation throughout 2023 and the first half of 2024, taking USDJPY to above 160 and prompting several rounds of FX intervention from Japanese officials.

But the tables started turning in summer when the European Central Bank (ECB), Bank of England (BOE) and Federal Reserve started to consider cutting rates to rebalance their economies after a period of restrictive policy to combat soaring inflation. At the same time, the Bank of Japan was starting to accept that the Japanese economy was experiencing increasing domestic inflation – which had been attributed to external factors throughout most of the post-covid recovery. This led to a need to gradually increase their base rate, taking it from -0.1% to the current 0.25%.

Clearly there is still a big rate differential which does not play in favour of the yen but there is expectation that the BOJ could increase rates by 25 basis points again in December, and this has been attracting buyers to the Japanese currency once again. Alongside a reversal in the US dollar over the past few days, USD/JPY has dropped 3.5% in the last 10 days, closing in on the 150 level once again.

USD/JPY daily chart

Past performance is not a reliable indicator of future results.

The same is happening against the pound and the euro where markets are rebalancing the rate differentials as both the BOE and ECB are expected to continue cutting rates over the coming year. The pullback could intensity further in EUR/JPY as the ECB is expected to be able to continue gradually reducing rates over the next few months. Markets are currently pricing in 130 basis points of cuts by June next year, which would take the base rate to just under 2%. The BOE and Fed are only expected to cut around 50 basis points in that same time period.

The expectation of less restrictive monetary policy in Europe could weaken the euro further. This could mean continued downside for EUR/JPY if the Bank of Japan is seen as hawkish over the coming months. The pair has dropped back below its key simple moving averages (20, 50, 100, 200) which suggests buyers will find resistance attempting to reverse higher, and therefore the path of least resistance remains lower for the time being. In the absence of any unexpected hawkishness from the ECB or dovishness from the BOJ then EUR/JPY could return to the lows seen in September below 156.50, at which point an ascending trendline from the 2024 lows could offer some support.

EUR/JPY daily chart

Past performance is not a reliable indicator of future results.



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