EUR/JPY eyes a test of key 131.50 resistance area, boosted back above 131.00 after hot Eurozone inflation

The euro has put in a solid performance on the final trading day of the first week of 2022. Though not the best performing currency in the G10, the euro has rallied about 0.4% versus the safe-haven yen and nearly 0.6% against the underperforming dollar. As a result, EUR/JPY has rallied from Asia Pacific session levels under 131.00 to current levels in the 131.30 area, with bulls eyeing an imminent test of the key 131.50 balance area, which market this week’s top and was a key area f support turned resistance in late-October/mid-November.

The euro’s outperformance on Friday likely has something to do with another Eurozone inflation surprise. Eurostat released the flash estimate of December Eurozone HICP inflation on Friday, which came in at 5.0% YoY from 4.9% in November versus forecasts for a drop to 4.7%. Meanwhile, the core measure also rose unexpectedly to 2.7% from 2.6% versus forecasts for it to remain unchanged. As Reuters put it, the data will likely make “for more uncomfortable reading at the European Central Bank, which has consistently underestimated price pressures and come under fire for this from some of its own policymakers”.

Risks are clearly tilted towards a further hawkish shift in ECB policy. Euro money markets earlier this week had a 10bps hike in October fully priced in, which seems excessive. As ECB Chief Economist Philip Lane reminded market participants on Monday, a 2022 rate hike is very unlikely. But Q1 2023 is very much on the cards and this is something hawkish ECB members have talked about in the past if inflation continues to surprise to the upside. A Q1 2023 rate hike would presumably be preceded APP QE purchases being axed by the end of Q4 2022.

Traders should be prepared to trade expectations for a widening ECB/BoJ policy divergence in 2022 and any associated widening impact this might have on Eurozone/Japan yields. For now, German 10-year yields remain below 0% and thus still below Japan 10-year yields. Much fanfare will likely be made if the German 10-year climbs back above the Japanese and such a move could well couple with EUR/JPY moving back towards Q4 2021 highs in the 133.50 area.