Euro steadies against Japanese Yen as ECB rate hike expectations strengthen

EUR/JPY trades around 183.80 on Thursday at the time of writing, little changed on the day. The Euro (EUR) retains some support against the Japanese Yen (JPY) as energy-driven inflation risks reinforce expectations that the European Central Bank (ECB) will deliver another interest rate hike in September.

A Reuters poll conducted from August 10 to 13 shows that 57 of 69 economists expect the ECB to raise its deposit rate by 25 basis points (bps) to 2.5% at its September meeting. Around 80% of economists also expect the rate to end the year at 2.5%, while 63% believe it will remain at that level until at least the third quarter of next year.

Money markets are even more firmly positioned, pricing in roughly a 90% chance of a 25 bps rate hike in September. These hawkish expectations limit the scope for aggressive bearish bets on the Euro and help support EUR/JPY.

On the macroeconomic front, Eurozone Industrial Production remained flat in June, compared with an expected 0.1% contraction. The figure paints a mixed picture of the Eurozone economy. At the same time, inflation risks stemming from energy prices keep investors focused on the ECB's monetary policy path.

On the Japan side, the Japanese Yen continues to face several fundamental headwinds. Wide interest rate differentials with other major economies, concerns over Japan's fiscal position and rising import costs continue to weigh on the currency.

Investors nevertheless remain attentive to signals from Japan's Ministry of Finance (MoF) regarding the possibility of further coordinated intervention between the United States (US) and Japan to support the Japanese Yen. Caution surrounding potential foreign exchange intervention helps limit more pronounced moves in EUR/JPY, although it has so far proved insufficient to reverse the fundamental pressures weighing on the Japanese currency.

Yen support builds as Japan backs faster BoJ tightening

Analysts at MUFG note that expectations build for a faster pace of BoJ policy tightening. They highlight a Bloomberg report stating that Prime Minister Takaichi’s government is supportive of a near-term BoJ hike, with “the next move likely in either September or October, according to people familiar with the matter.” The report suggests that the BoJ’s “fears over [Y]en weakness driving up prices” and the government’s desire to “strengthen the impact of the recent US-Japan currency intervention” are aligning policymakers on the need for a near-term move.

MUFG points out that the impact on Japanese rate market pricing has been “relatively limited” given that participants had already moved to “fully price in a hike by October” and that “there are currently around 19bps of hikes priced in by September.” They add that the Bloomberg story “fits with our own initial view that there was likely an agreement to allow the BoJ to continue to normalize policy in exchange for the US providing support for the yen through joint intervention at the end of July.”

According to MUFG, Kyodo news reported earlier this week that joint intervention was made possible by BoJ Governor Ueda’s hawkish tone at the 31 July policy meeting, where he stated explicitly that, if necessary, the BoJ would “accelerate the pace of rate hikes.” The US was reportedly concerned that delays in raising rates would lead to “excessive yen weakness, which in turn could fuel further inflation and higher long-term interest rates, with repercussions across financial markets.” MUFG notes that the report “went on to conclude that the BoJ has ‘effectively left itself with no option other than a rate hike at its next Monetary Policy Meeting on 17th-18th September’.”

With USD/JPY rising back toward the 160.00 level, MUFG stresses that “market participants will be watching closely to see if Japan is willing to step back into the FX market to support the [Y]en.” At a minimum, Japanese policymakers will be hoping that the “heightened threat of intervention helps to slow the pace of [Y]en weakness,” with recent price action underlining that it will be “difficult for the BoJ to avoid hiking rates in September and disappointing market expectations, which would encourage further [Y]en selling.”