British Pound edges higher as fiscal risks and rate gap weigh on Yen

The GBP/JPY cross edges higher on Tuesday, though it lacks bullish conviction and remains confined within a familiar range held over the past week or so. Spot prices currently trade around mid-216.00s amid a broadly weaker Japanese Yen (JPY).

Japan's benchmark 10-year bond yield hit 3% for the first time since September 1996 amid inflation risks stemming from higher energy prices and mounting pressure on the Bank of Japan (BoJ) to hike interest rates faster. This would increase the cost of servicing Japan's massive debt pile at a time when ​Prime Minister Sanae Takaichi is planning aggressive investment, adding to worries about the country's worsening fiscal condition. This, in turn, is seen as a key factor undermining the JPY and acting as a tailwind for the GBP/JPY cross.

Analysts at Rabobank highlight a fresh source of policy friction after US Treasury Secretary Scott Bessent appeared to nudge the BoJ toward faster tightening, even as the Japanese government has sought to discourage any rush to raise rates. Rabobank notes that Bessent prefaced his remarks by saying he was not going to tell the BoJ what to do, but then suggested that “the reflationary policies of Abenomics have run their course” and that “coordinated intervention in FX markets could only go so far.” Underscoring the assertive tone of his intervention, Bessent added: “I can’t affect the natural equilibrium. What I can do is send a signal and, as I’ve said, I have information that the market doesn’t have.”

Meanwhile, borrowing costs in Japan remain significantly lower than in other major economies, including the UK, which keeps the so-called carry trade active and contributes to the weaker tone surrounding the JPY. The BoJ increased its short-term policy rate to 1.00% in June and is expected to hike again this month. The Bank of England (BoE) has maintained its benchmark rate at 3.75%, still leaving a sizeable difference of over 250 basis points (bps). This, in turn, backs the case for some meaningful appreciating move for the GBP/JPY cross.

However, a pickup in the US Dollar (USD) demand is seen exerting some pressure on the British Pound (GBP) and holding back bulls from placing aggressive bets. Nevertheless, the supportive fundamental backdrop suggests that any corrective pullback could be seen as a buying opportunity and is more likely to remain limited. Traders now look to the release of the final UK Manufacturing PMI, though BoE Governor Andrew Bailey's speech on Friday should provide some meaningful impetus to the GBP/JPY cross.