Euro Gains Against Yen on Diverging Central Bank Views

Key Moments

Euro Firm Against Yen in Early European Trade

The EUR/JPY cross is seeing modest upside, trading near 184.90 in early European hours on Thursday. The Euro (EUR) is outperforming the Japanese Yen (JPY) as market participants react to hawkish commentary from European Central Bank (ECB) officials and shifting expectations for the ECB’s policy path.

ECB Rate Expectations Turn More Hawkish

A Reuters poll showed a notable shift in market expectations for the ECB’s next move. Around 85% of surveyed economists now anticipate that the central bank will lift its deposit rate by 25 basis points to 2.25% in June, compared with just over half who held that view before the April meeting.

ECB policymaker Joachim Nagel added to the hawkish tone on Wednesday, stating that the likelihood the central bank will need to increase borrowing costs as a result of the Iran war is rising.

At the same time, ECB Chief Economist Philip Lane emphasized the need for caution, saying that officials must carefully analyze the impact on growth and inflation before reaching a decision, and that determining the appropriate monetary policy stance is a judgment call.

BoJ Officials Highlight Energy Shock Risks

On the Japanese side, Bank of Japan (BoJ) policy board member Kazuyuki Masu warned on Thursday that the energy shock stemming from the Iran war could hit Japan’s economy harder than the 1973 oil crisis, and said the associated risk requires attention.

Masu also noted that with the policy rate hovering near the estimated neutral level, the BoJ must more closely scrutinize price developments, labor market conditions, and financial markets when considering additional policy moves.

Intervention Fears Support the Yen

Despite the Euro’s current strength, lingering concerns about potential foreign exchange intervention by Japanese authorities could lend support to the Yen and limit further upside in EUR/JPY.

Japan’s Finance Minister Satsuki Katayama said last week that “regarding recent currency moves, we confirmed that Japan and the US have been coordinating very well and have maintained close communication.”

Background: Key Drivers of the Japanese Yen

Fundamental Influences on JPY

The Japanese Yen is described as one of the most actively traded currencies globally. Its valuation is primarily linked to the performance of the Japanese economy, with particular sensitivity to the Bank of Japan’s policy stance, the spread between Japanese and US bond yields, and overall risk sentiment among market participants, among other factors.

Impact of Bank of Japan Policy

One of the BoJ’s mandates is currency control, making its decisions especially important for the Yen. The central bank has at times directly intervened in foreign exchange markets, typically to weaken the Yen, while generally exercising restraint due to political considerations with key trading partners.

The BoJ’s ultra-loose monetary policy between 2013 and 2024 led to Yen depreciation against major counterparts, as policy diverged from other central banks. More recently, a gradual unwinding of this highly accommodative stance has provided some support to the currency.

Role of Yield Differentials

Over roughly the past decade, the BoJ’s commitment to ultra-loose policy contributed to a widening policy gap with other central banks, notably the US Federal Reserve. This dynamic helped expand the spread between 10-year US and Japanese government bond yields, favoring the US Dollar over the Yen.

The BoJ’s 2024 decision to slowly move away from ultra-loose policy, combined with interest rate reductions at other major central banks, is narrowing this yield differential.

Safe-Haven Characteristics

The Japanese Yen is often perceived as a safe-haven asset. In periods of financial market stress, investors are more inclined to allocate capital to the Yen, reflecting its perceived reliability and stability. As a result, episodes of turbulence tend to bolster the Yen against currencies viewed as carrying higher risk.