EUR/JPY falls as Bank of Japan faces pressure to raise rates
- EUR/JPY slips on upbeat Japanese data and elevated inflation.
- Germany’s Retail Sales and preliminary inflation figures provide a mixed picture for the Euro, providing an additional headwind for the ECB.
- A hawkish Bank of Japan and a data-dependent European Central Bank drive EUR/JPY price action.
The Euro (EUR) is coming under renewed pressure against the Japanese Yen (JPY) as investors weigh persistent inflation in Japan against soft consumer and inflation data from the Eurozone. With the European Central Bank (ECB) already in easing mode and the Bank of Japan (BoJ) edging toward further policy tightening, the broader backdrop is shifting in favour of the Yen.
At the time of writing, EUR/JPY is trading below 164.00, with the next layer of support resting at 163.00.
Resilient Retail Sales and rising inflation in Japan support the Yen
Japan’s latest data has reignited expectations for further tightening from the BoJ. Tokyo’s Core Consumer Price Index (CPI), a leading inflation indicator, rose 3.4% YoY in May, compared to 3.5% the previous month, while the CPI excluding fresh food rose 3.6%, its highest level in two years. The data showed that the increase was driven by sharply higher food prices, including a 93% surge in rice costs.
Retail sales also exceeded expectations, rising 3.3% YoY in April, indicating that consumer demand remains resilient despite rising prices. Industrial production contracted by 0.9% MoM in April, a smaller decline than the 1.4% contraction expected, adding to evidence that Japan’s economy is holding up better than anticipated.
Together, these figures have strengthened the case for another rate hike from the Bank of Japan. Having already exited negative interest rates earlier this year, the central bank is under increasing pressure to normalise policy further, especially if inflation continues to surprise on the upside.
German Retail Sales and inflation provide mixed signals
By contrast, recent data from Germany, the Eurozone’s largest economy, painted a more fragile picture. Retail sales in April declined by 1.1% MoM, missing expectations for a 0.2% increase. Although the YoY figure showed some strength at 2.3%, the sharp monthly drop raised concerns about the health of domestic demand.
Inflation data was mostly in line, though the Harmonised Index of Consumer Prices (HICP)—the European Union’s standardised measure- came in slightly above expectations, rising 0.2% MoM and 2.1% YoY. Still, the ECB remains data-dependent, balancing the economic outlook with inflation expectations.
EUR/JPY reviews policy divergence expectations between the ECB and the BoJ
The policy divergence between the European Central Bank and the Bank of Japan is becoming increasingly clear. While the ECB looks set to continue reducing rates cautiously amid mixed economic signals, the BoJ is under growing pressure to tighten further as inflation gains traction.
This divergence supports a bearish bias for the EUR/JPY pair. As long as Japanese inflation remains firm and economic activity continues to hold up, the Yen is likely to remain supported. Meanwhile, the Euro could come under further pressure if Eurozone growth data continues to underwhelm or if the ECB signals the potential for additional rate cuts.
Bank of Japan FAQs
The Bank of Japan (BoJ) is the Japanese central bank, which sets monetary policy in the country. Its mandate is to issue banknotes and carry out currency and monetary control to ensure price stability, which means an inflation target of around 2%.
The Bank of Japan embarked in an ultra-loose monetary policy in 2013 in order to stimulate the economy and fuel inflation amid a low-inflationary environment. The bank’s policy is based on Quantitative and Qualitative Easing (QQE), or printing notes to buy assets such as government or corporate bonds to provide liquidity. In 2016, the bank doubled down on its strategy and further loosened policy by first introducing negative interest rates and then directly controlling the yield of its 10-year government bonds. In March 2024, the BoJ lifted interest rates, effectively retreating from the ultra-loose monetary policy stance.
The Bank’s massive stimulus caused the Yen to depreciate against its main currency peers. This process exacerbated in 2022 and 2023 due to an increasing policy divergence between the Bank of Japan and other main central banks, which opted to increase interest rates sharply to fight decades-high levels of inflation. The BoJ’s policy led to a widening differential with other currencies, dragging down the value of the Yen. This trend partly reversed in 2024, when the BoJ decided to abandon its ultra-loose policy stance.
A weaker Yen and the spike in global energy prices led to an increase in Japanese inflation, which exceeded the BoJ’s 2% target. The prospect of rising salaries in the country – a key element fuelling inflation – also contributed to the move.
Author
Tammy Da Costa, CFTe®
FXStreet
Tammy is an economist and market analyst with a deep passion for financial markets, particularly commodities and geopolitics.
