British Pound holds steady around 213.00 as fiscal concerns and rate gap undermine Yen

The GBP/JPY cross struggles to extend its positive move witnessed over the past three days and consolidates around the 213.00 mark, or the top end of its weekly range, through the early European session on Friday. Spot prices, for now, seem to have stalled this week's solid recovery move from the vicinity of mid-209.00s, or the lowest level since early March.

The US Dollar (USD) preserves the previous day's gains amid persistent geopolitical uncertainties, exerting some pressure on the British Pound (GBP), which, in turn, is seen acting as a headwind for the GBP/JPY cross. The downside, however, remains cushioned as concerns about Japan's worsening fiscal condition continue to undermine the Japanese Yen (JPY) amid a wide rate gap between Japan and other major economies, including the UK.

In fact, Japan's government on Wednesday signed off on Prime Minister Sanae Takaichi's flagship plan to slash the consumption ​tax on food items to 1% from 8% for two years. Adding to this, Japan’s ruling Liberal Democratic Party (LDP) backed a proposal for roughly ¥600 billion a year in cash transfers targeted at low- and middle-income households. This would add to the nation's already strained finances, which, in turn, undermines the JPY.

Analysts at Rabobank note that, just days after the Japanese Ministry of Finance – and the US Treasury – intervened in FX markets to prop up the Yen, the cabinet has approved a plan to cut the sales tax on food for two years, alongside additional handouts to lower-income households. They highlight that “high costs of living are weighing on PM Takaichi’s popularity,” prompting a policy response that is already drawing scrutiny.

Rabobank points out that the “unfunded tax plan has drawn criticism from both the opposition and people within the ruling LDP, as well as market participants,” even though “today’s 30-year bond auction showed little sign of concern or investor fatigue.” In their view, however, “the real litmus test may be the currency,” with the sustainability of Japan’s policy mix likely to be judged in the Yen rather than in the JGB market.

Meanwhile, data released earlier today showed that consumer spending fell 3.3% year-on-year in June, defying expectations for a rise and marking the seventh straight month of contraction. This underscores persistent weakness in domestic demand and weakens the case for another Bank of Japan (BoJ) rate hike in September. It is worth recalling that the BoJ lifted the short-term policy rate in June to 1.00%, or the highest since 1995.

The Bank of England's (BoE) base rate, on the other hand, is at 3.75%, leaving an interest rate differential of around 275 basis points (bps). This keeps the so-called carry trade active, which should hold back JPY bulls from placing aggressive bets and further lend support to the GBP/JPY cross. Nevertheless, spot prices remain on track to register modest weekly gains and seem poised to climb further amid a supportive fundamental backdrop.