Euro advances against Japanese Yen as German business sentiment improves

EUR/JPY advances to around 185.85 on Tuesday at the time of writing, gaining 0.15% on the day. The cross benefits from strength in the Euro (EUR), supported by a stronger-than-expected improvement in German business sentiment, while the Japanese Yen (JPY) remains weighed down by concerns surrounding Japan’s public finances and the persistence of a wide interest-rate differential.

The IFO Institute Business Climate Index improves to 88.8 in August from a revised 86.7 in July, beating market expectations of 87.2. The increase signals improving business sentiment in the Eurozone’s largest economy and provides support to the single currency.

The survey’s components also come in above expectations. The Current Assessment Index rises to 88.5 from 86.5 previously, exceeding the market consensus of 87. Meanwhile, the Expectations Index jumps to 89.1 from a revised 86.8 in July, also beating the 87.5 forecast.

On the Japanese side, fears of another intervention in the foreign exchange market limit the extent of Japanese Yen selling. However, several fundamental factors continue to prevent a sustained appreciation of the Japanese currency.

Investors remain concerned about Japan’s deteriorating fiscal position amid rising long-term interest rates, a massive public debt burden and pressures for expansionary fiscal policy. At the same time, Japanese interest rates remain significantly below those of other major economies, maintaining the appeal of Yen-funded carry trades.

The interest-rate gap between the Bank of Japan (BoJ) and other major central banks therefore remains a persistent headwind for the Japanese currency. These factors have largely offset the impact of the coordinated US-Japan intervention in the foreign exchange market in late July and continue to support EUR/JPY.

Eurozone walks a fine line as growth firms and inflation pressures ease

Strategists at BNY Mellon stress that “inflation remains the core issue in Europe,” even as signs of a cyclical upturn become more evident. They argue that while “activity is improving,” “tightening too early would be a mistake,” particularly with the Euro “near cyclical highs and already doing some of the tightening.” In their view, Europe is aiming for “growth without reigniting inflation,” and the preliminary August PMIs point to a tentative “Goldilocks” mix: “manufacturing intentions are improving, while services remain in moderate contraction,” and “the ECB’s latest inflation expectations survey shows easing.” Against this backdrop, BNY Mellon contends that “the ECB is right to stay vigilant, but it should not move too soon.”

The bank notes that “Europe’s week centers on inflation relief,” with “French and Spanish flash CPI on Friday” described as “the main releases,” and highlighting that “Spain [is] still running much hotter than France.” At the same time, “German unemployment data on Friday provides a labor-market read for the Eurozone’s largest economy.” The complication, they add, “is growth”: “activity is turning higher,” and “recent PMIs show demand improving as supply pressures ease,” underscoring the delicate balance the ECB must strike between consolidating disinflation and not choking off an emerging recovery.