Euro gains against Japanese Yen as ECB, BoJ rate hike bets intensify

EUR/JPY rises 0.15% on Friday and trades around 184.15 at the time of writing. The pair remains supported despite growing expectations that Japan could raise interest rates as soon as September, while investors also anticipate further monetary tightening in the Eurozone.

On the European side, markets widely expect the European Central Bank (ECB) to raise interest rates at its September meeting, which would mark its second hike this year. Risks surrounding Eurozone inflation remain tilted to the upside, keeping the prospect of further monetary tightening alive and providing support to the Euro (EUR).

The latest growth figures also provide a relatively supportive backdrop for the single currency. Eurostat's second estimate confirms on Friday that Eurozone Gross Domestic Product (GDP) expanded by 0.4% QoQ in the second quarter, in line with the preliminary estimate released in July and following no growth in the previous quarter.

On an annual basis, Eurozone GDP grew by 1% in the second quarter, matching the preliminary estimate and accelerating from an upwardly revised 0.5% increase in the previous quarter. The figures suggest that economic activity in the Eurozone is regaining some momentum, while the ECB also has to contend with persistent upside inflation risks.

However, the Japanese monetary policy outlook limits EUR/JPY's upside potential. Expectations are growing that the Bank of Japan (BoJ) could raise interest rates as soon as its September meeting. Reuters reported on Friday, citing three sources familiar with the central bank's thinking, that the BoJ could raise rates as soon as next month and subsequently consider a faster pace of monetary tightening.

These expectations support the Japanese Yen (JPY), while the possibility of further intervention in the foreign exchange market also remains under scrutiny. Japan's Ministry of Finance said that the United States (US) and Japan jointly intervened in late July to counter “excessive volatility and disorderly movements” in the Japanese Yen observed in recent months.

With monetary tightening expectations strengthening simultaneously in the Eurozone and Japan, EUR/JPY therefore remains caught between support for the Euro from expectations of an ECB rate hike and support for the Japanese Yen from prospects of a faster normalization of BoJ monetary policy.

Eurozone rate path divides as ECB hawks meet dovish pushback

Analysts at Nordea note that “the ECB’s message at the July meeting was still in line with further rate hikes to come,” and reiterate that they “continue to expect three more 25bp increases, taking the deposit rate to 3%, but revised the expected path of these hikes last month from consecutive to quarterly moves.” Their “updated baseline assumes 25bp rate hikes in September, December and March 2027,” reflecting a slower but still distinctly hawkish trajectory. Nordea cautions that geopolitical developments could materially reshape the outlook, arguing that “a quick and durable peace in the Middle East could reduce the pressure on the ECB to hike further, while a more notable escalation and longer-lasting disruption to energy markets could lead to faster and potentially more rate increases.” Even under this moderated hiking pace, they add that “we still see room especially for longer bond yields to climb, supported by ample bond supply, Eurosystem reductions in bond holdings and higher inflation-risk premia.”

Commerzbank takes a more cautious view on the extent of further tightening. Strategists there state that, “like the market, we expect a second rate hike in September, but—contrary to market expectations—we do not anticipate any further (third) rate hike beyond that.” In their assessment, “with a deposit rate then expected to be 2.5%, a level would be reached that Governing Council members view as the upper limit of the neutral interest rate—one that neither stimulates nor slows the economy and leads to medium-term inflation.” Looking further ahead, Commerzbank expects the policy stance to eventually reverse, judging that “toward the end of 2027, the ECB is likely to lower interest rates again,” as “inflation should gradually decline over the course of the coming year and come close to reaching the inflation target.”

Yen underperforms as Japan data bolster BoJ hike expectations

Analysts at ING highlight that, “despite some sharp moves in Japanese money markets this week, the Yen is failing to find any lasting support.” They argue that “the big story is that the Japanese government might be more tolerant of a faster tightening cycle by the BoJ,” with markets now assigning “close to a 75% chance that the BoJ hikes 25bp in September.” ING notes that this repricing has already seen “two-year US:Japan swap differentials narrow nearly 40bp since mid-July,” underscoring how policy expectations are shifting even as USD/JPY remains elevated.

Economists at DBS add a fundamental backdrop to this market narrative, projecting that Japan’s “GDP growth is expected to post an on-trend rate of 0.8% QoQ saar, albeit lower than the 1.8% recorded in 1Q.” In their view, “overall, the data will likely strengthen the case for an early rate hike by the Bank of Japan at its September meeting.” However, DBS cautions that “an actual move would still hinge on market dynamics, including USD/JPY movements and the outcome of the September FOMC meeting,” suggesting that both domestic conditions and US policy signals will be critical in determining the BoJ’s next step.