The EUR/JPY cross gathered significant strength during the early European session on Thursday, pushing towards the 185.20 mark. This upward momentum was primarily fueled by a notable softening of the Japanese Yen (JPY) following the release of disappointing Japanese Gross Domestic Product (GDP) data. Market participants are now keenly awaiting Japan’s National Consumer Price Index (CPI) inflation report, scheduled for publication on Friday, which is expected to provide further clarity on the Bank of Japan’s (BoJ) monetary policy trajectory.
Japan’s Economic Growth Underperforms Expectations
Japan’s economic performance in the second quarter (Q2) of the fiscal year fell short of market consensus, with GDP expanding by a modest 0.3%. This figure contrasts sharply with the 0.5% growth recorded in the preceding quarter and missed the market’s expectation, which had also been set at 0.5%. The subdued growth rate raises questions about the underlying resilience of the Japanese economy, which has been grappling with various domestic and international headwinds.
Breaking down the GDP components, consumption, a crucial driver of economic activity, showed only marginal improvement, reflecting persistent cautiousness among households. Business investment also appeared restrained, possibly due to global economic uncertainties and higher input costs. Exports, while contributing positively, faced challenges from a slowing global economy, particularly in key markets like China and Europe. Imports, on the other hand, remained elevated, exacerbated by a weaker Yen and higher global commodity prices, leading to a less favorable net export contribution than hoped.
Yoshiki Shinke, a senior executive economist at Dai-ichi Life Research Institute, commented on the situation, noting, "There were views that Japan’s economy might even slip into negative growth due to higher import prices and supply constraints driven by the aggravated Iran situation." This highlights the fragility of Japan’s recovery, which is highly susceptible to external shocks such as geopolitical tensions impacting energy and raw material costs. The rise in import prices directly translates to higher costs for businesses and consumers, potentially stifling demand and investment.
The GDP data underscores the complex challenge faced by the Bank of Japan. While the central bank has been gradually moving away from its ultra-loose monetary policy, persistent signs of economic weakness could temper expectations for an aggressive tightening cycle. A softer economy makes it harder for the BoJ to justify significant interest rate hikes, as such moves could further dampen growth.
Anticipating Japan’s National CPI Report
The focus now shifts to Friday’s National Consumer Price Index (CPI) report, a critical piece of data that will heavily influence market perceptions of the BoJ’s near-term policy direction. Inflation trends in Japan have been a central theme in recent monetary policy discussions, with the BoJ aiming to achieve a sustainable 2% inflation target, accompanied by robust wage growth.
For many years, Japan struggled with deflation, a persistent decline in prices that can stifle economic activity by discouraging spending and investment. The BoJ’s massive quantitative easing program, introduced in 2013, aimed to pull the economy out of this deflationary spiral. More recently, driven by global supply chain disruptions, energy price surges, and a weaker Yen, Japan has seen inflation rates rise above the 2% target. However, the key question for the BoJ is whether this inflation is demand-driven and sustainable, or largely cost-push and temporary.
Analysts will scrutinize the core CPI figures, which exclude volatile fresh food prices, and even more so, the "core-core" CPI, which strips out both fresh food and energy, as these measures provide a clearer picture of underlying inflationary pressures. A higher-than-expected CPI reading, particularly in the core measures, could reinforce expectations for the BoJ to continue its path towards policy normalization. Conversely, a softer-than-expected report might lead to a reassessment of the timing and pace of future rate hikes, potentially weighing further on the Yen.
The Bank of Japan’s Evolving Monetary Policy
The Bank of Japan’s monetary policy has been a defining characteristic of the global financial landscape for over a decade. Since 2013, under the leadership of former Governor Haruhiko Kuroda, the BoJ embarked on an unprecedented ultra-loose policy framework, characterized by negative interest rates and an aggressive yield curve control (YCC) mechanism designed to cap long-term government bond yields at around zero. This policy was aimed at combating deflation and stimulating economic growth.
This prolonged period of ultra-loose policy led to a significant divergence with other major central banks, particularly the US Federal Reserve and the European Central Bank, which had largely completed their post-financial crisis quantitative easing and were moving towards tightening cycles. This divergence contributed to a substantial weakening of the Japanese Yen against its major peers, making Japanese exports more competitive but also increasing the cost of imports.
However, in recent months, the BoJ has shown signs of gradually unwinding this extraordinary policy. While still maintaining negative interest rates, the central bank has adjusted its YCC band, allowing for greater flexibility in long-term bond yields. These moves have been interpreted by the market as preliminary steps towards a more conventional monetary policy stance.
Growing market bets now suggest that the Bank of Japan could raise interest rates as early as September 2026. Overnight index swaps are currently pricing in an approximately 80% chance of a BoJ rate hike in the next policy meeting, according to Reuters. This significant probability reflects a market conviction that the BoJ will eventually normalize its policy, driven by persistent inflation and a desire to bring monetary policy back into line with global norms. A move away from negative rates would mark a historic shift, ending an era of unprecedented monetary experimentation. The timing of this shift, however, remains highly sensitive to economic data, particularly inflation and wage growth figures. Sustained wage increases are crucial for the BoJ to confirm that inflation is demand-driven and sustainable, rather than merely a temporary phenomenon caused by external factors.
The Yen’s Sensitivity: Yield Differentials and Safe-Haven Status
The Japanese Yen’s value is profoundly influenced by the Bank of Japan’s policy and the resulting interest rate differentials with other major economies. When the BoJ maintains ultra-low rates while other central banks raise theirs, the yield on Japanese government bonds becomes less attractive compared to bonds from the US or Eurozone. This "yield differential" encourages investors to sell Yen and buy higher-yielding currencies, leading to Yen depreciation. This phenomenon makes the JPY a popular "funding currency" for carry trades, where investors borrow in low-interest-rate JPY and invest in higher-yielding assets elsewhere.
Conversely, as the BoJ begins to tighten its policy and other central banks potentially pause or even cut rates, this differential is expected to narrow. A narrowing differential would reduce the incentive for carry trades and could provide significant support to the Yen, as its relative attractiveness increases. The BoJ’s decision in 2024 to gradually abandon the ultra-loose policy, coupled with anticipated interest-rate cuts in other major central banks, is precisely this scenario, which is expected to narrow this differential over time.
Beyond monetary policy, the Japanese Yen is often considered a "safe-haven" investment. In times of heightened global economic uncertainty, geopolitical instability, or financial market stress, investors tend to flock to assets perceived as reliable and stable. The JPY, alongside the US Dollar and Swiss Franc, has historically benefited from this flight to safety. Its deep liquidity, the strong net creditor position of Japan, and relatively stable political environment contribute to this perception. Turbulent times are likely to strengthen the Yen’s value against other currencies seen as more risky. However, this safe-haven characteristic can sometimes be overshadowed by overwhelming interest rate differentials, as has been the case during the recent period of aggressive global monetary tightening.
Danske Bank’s Outlook on ECB Rate Hikes
While the Bank of Japan contemplates its exit from ultra-loose policy, the European Central Bank (ECB) has been engaged in a robust tightening cycle to combat persistent inflation within the Eurozone. However, analysts at Danske Bank maintain a more restrained view on the remaining tightening cycle for the ECB. They reiterate their expectation for "only one further 25bp rate hike from the ECB."
This forecast reflects Danske Bank’s assessment that, beyond a single additional move, the case for further policy tightening is likely to diminish. The rationale behind this view likely stems from several factors. Firstly, there are increasing signs that Eurozone inflation, while still elevated, may be peaking or moderating, particularly in its headline components due to easing energy prices. Secondly, concerns about the economic growth outlook for the Eurozone are growing. The cumulative impact of past rate hikes, coupled with ongoing geopolitical uncertainties, could be slowing economic activity, making further aggressive tightening undesirable to avoid pushing the region into a deeper recession. Thirdly, the ECB often considers the "lag effect" of monetary policy, meaning that the full impact of previous rate hikes has yet to be felt in the economy.
The ECB’s primary mandate is price stability, aiming for a 2% inflation target over the medium term. Over the past year, the central bank has aggressively raised its key interest rates, moving them from negative territory to levels not seen in over a decade. This aggressive stance was a direct response to record-high inflation rates, driven by energy price shocks, supply chain disruptions, and robust demand post-pandemic. While the ECB has signaled its commitment to bringing inflation back to target, the pace and extent of future hikes are subject to ongoing data dependency. Danske Bank’s more cautious stance suggests they believe the bulk of the necessary tightening has already occurred, and future moves will be more calibrated and data-driven. This outlook for a more limited tightening path for the ECB could temper the Euro’s upward potential against currencies whose central banks are expected to continue tightening or those, like the JPY, where the tightening path is less certain.
Technical Analysis: EUR/JPY Retains Bullish Tone
From a technical perspective, the EUR/JPY currency pair continues to exhibit a bullish near-term bias on the daily chart. The price action remains comfortably above its 100-day Simple Moving Average (SMA) at 185.10, a key indicator often used to gauge the medium-term trend. Furthermore, the pair is trading above the 20-day Bollinger middle band, which also suggests underlying demand on dips and reinforces the constructive outlook.
The Relative Strength Index (RSI 14), a momentum oscillator, is currently hovering around 56.75. This reading, comfortably above the neutral 50 line, indicates that there is still healthy buying momentum in the market without being in an overbought condition, which typically signals a potential reversal. The exchange rate is currently consolidating just under recent highs, suggesting that bulls are regrouping before attempting further gains.
Looking at key levels, immediate resistance for the EUR/JPY pair emerges at the June 17 high of 186.32. A decisive break above this level would signal renewed bullish conviction and open the door for further upside. The next significant hurdle for bulls is seen at the upper Bollinger Band, currently around 187.50. This level caps the current trading range and represents the next objective for buyers, potentially indicating a move towards previous multi-year highs if momentum sustains.
On the downside, initial support aligns with the aforementioned 100-day SMA at 185.10. A breach below this level could signal a temporary weakening of the bullish trend. The next layer of support is provided by the Bollinger middle band, currently near 184.00. A deeper pullback that penetrates these support levels would expose the August 10 low of 182.70. Should selling pressure intensify and push the pair below 182.70, the lower Bollinger Band, down at 180.55, would likely act as a strong area of buying interest, potentially halting the decline if the broader uptrend remains intact. Traders will be closely watching these technical levels in conjunction with upcoming fundamental data to gauge the pair’s next significant move.
Broader Implications and Outlook
The current dynamics in the EUR/JPY cross underscore the profound influence of central bank policy divergence and economic data on currency markets. The weakening Yen, driven by disappointing domestic growth and the legacy of ultra-loose monetary policy, continues to offer a relatively attractive funding currency for investors. Meanwhile, the Euro benefits from the ECB’s ongoing, albeit potentially winding down, tightening cycle, which aims to bring down stubbornly high inflation in the Eurozone.
For Japanese businesses, a weaker Yen makes exports more competitive on the global stage, potentially boosting corporate profits and contributing to economic growth. However, it also increases the cost of imports, particularly for energy and raw materials, which can fuel domestic inflation and squeeze profit margins for import-dependent sectors. For Eurozone businesses, a stronger Euro can make imports cheaper, helping to alleviate inflationary pressures, but it can also make their exports more expensive, potentially impacting competitiveness.
Looking ahead, the trajectory of the EUR/JPY cross will be heavily dependent on several key factors. On the Japanese side, the upcoming CPI report will be crucial. Any signs of cooling inflation or persistent economic weakness could push back the market’s expectations for a BoJ rate hike, further weighing on the Yen. Conversely, stronger-than-expected inflation, particularly if accompanied by rising wages, could accelerate the BoJ’s normalization timeline and provide significant support to the JPY.
In the Eurozone, the ECB’s future policy decisions will be paramount. While Danske Bank anticipates only one more hike, other analysts may hold different views, and the ECB’s own rhetoric remains data-dependent. Any surprises in Eurozone inflation data or shifts in the ECB’s hawkish stance could significantly impact the Euro’s strength.
Furthermore, global risk sentiment and geopolitical developments, such as the ongoing situation in Iran mentioned by Mr. Shinke, will continue to play a role. As a safe-haven currency, the Yen tends to strengthen during periods of global uncertainty, but this effect can be mitigated by overwhelming interest rate differentials. The interplay of these complex factors will dictate the future direction of the EUR/JPY cross, keeping market participants on high alert for upcoming economic releases and central bank pronouncements.
