Euro rebounds from multi-day low as carry trade undermines JPY; focus remains on ECB

EUR/JPY regains positive traction following the recent corrective slide from a one-month top.
The carry trade weighs on the JPY, and a softer USD benefits the Euro, supporting spot prices.
Intervention fears help limit JPY losses and might cap the cross ahead of the ECB on Thursday.

Haresh Menghani FXStreet

The EUR/JPY cross attracts some dip-buyers on Tuesday, snapping a three-day losing streak and stalling its recent retracement slide from the 186.00 mark or a nearly one-month high touched last week. Spot prices stick to modest intraday gains through the early European session and currently trade around the 185.75 region, up 0.15% for the day.

The Japanese Yen (JPY) continues with its relative underperformance amid deeply entrenched interest rate differentials between Japan and other major economies, including the Eurozone, which keeps the so-called carry trade active. The shared currency, on the other hand, benefits from a softer US Dollar (USD) and turns out to be another factor lending some support to the EUR/JPY cross.

The Bank of Japan (BoJ) has cautiously started to normalize policy and lifted the short-term policy rate to 1.00%, or the highest since 1995. Meanwhile, the European Central Bank's (ECB) deposit facility rate is at 2.25%. This leaves a gap of around 125 basis points (bps), prompting traders to use the low-yielding JPY as a funding currency to finance purchases of higher-yielding currencies like the Euro.

The JPY bears, however, remain on high alert amid speculations that authorities will step in to prop up the domestic currency. This, in turn, might keep a lid on any further appreciation for the EUR/JPY cross. Traders might also opt to move to the sidelines ahead of the highly-anticipated ECB meeting on Thursday, which will play a key role in providing some meaningful impetus to the cross.

Apart from this, the market focus this week will be on the release of Japan's consumer inflation figures and the flash global PMIs on Friday, which could further help determine the near-term trajectory for the EUR/JPY cross. In the meantime, the German ZEW Indicator of Economic Sentiment could produce short-term opportunities. Nevertheless, the fundamental backdrop seems tilted in favor of bulls.

ECB FAQs

What is the ECB and how does it influence the Euro?

The European Central Bank (ECB) in Frankfurt, Germany, is the reserve bank for the Eurozone. The ECB sets interest rates and manages monetary policy for the region. The ECB primary mandate is to maintain price stability, which means keeping inflation at around 2%. Its primary tool for achieving this is by raising or lowering interest rates. Relatively high interest rates will usually result in a stronger Euro and vice versa. The ECB Governing Council makes monetary policy decisions at meetings held eight times a year. Decisions are made by heads of the Eurozone national banks and six permanent members, including the President of the ECB, Christine Lagarde.

What is Quantitative Easing (QE) and how does it affect the Euro?

In extreme situations, the European Central Bank can enact a policy tool called Quantitative Easing. QE is the process by which the ECB prints Euros and uses them to buy assets – usually government or corporate bonds – from banks and other financial institutions. QE usually results in a weaker Euro. QE is a last resort when simply lowering interest rates is unlikely to achieve the objective of price stability. The ECB used it during the Great Financial Crisis in 2009-11, in 2015 when inflation remained stubbornly low, as well as during the covid pandemic.

What is Quantitative tightening (QT) and how does it affect the Euro?

Quantitative tightening (QT) is the reverse of QE. It is undertaken after QE when an economic recovery is underway and inflation starts rising. Whilst in QE the European Central Bank (ECB) purchases government and corporate bonds from financial institutions to provide them with liquidity, in QT the ECB stops buying more bonds, and stops reinvesting the principal maturing on the bonds it already holds. It is usually positive (or bullish) for the Euro.

Author

Haresh Menghani

FXStreet

Haresh Menghani is a detail-oriented professional with 10+ years of extensive experience in analysing the global financial markets.

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