EUR/JPY Climbs as BoJ Holds, Flags Inflation

Key Moments

EUR/JPY Extends Rally After BoJ Decision

EUR/JPY climbed toward 185.20 during Friday’s Asian session after the Bank of Japan left its benchmark interest rate unchanged at 1%. The decision matched market expectations and passed by an 8-1 vote.

However, board member Hajime Takata dissented. He supported a 25-basis-point rate increase that would have lifted the policy rate to 1.25%.

BoJ Maintains Hawkish Bias and Highlights Inflation Risks

Despite leaving rates unchanged, the BoJ reaffirmed its tightening bias. Officials expect medium- to long-term inflation expectations to continue rising. They also reiterated that further rate hikes will depend on economic conditions, inflation trends, and financial market developments.

Even so, investors largely expected this message. Markets believe policymakers are unlikely to deliver consecutive rate hikes that could slow Japan’s economic recovery. Earlier, at the June meeting, the BoJ raised rates by 25 basis points to 1%, the highest level since 1995.

Focus Turns to Eurozone Inflation Data

Attention now shifts to the Eurozone’s preliminary July Harmonized Index of Consumer Prices (HICP), scheduled for release at 09:00 GMT. Earlier inflation reports from Germany and Spain surprised to the upside, suggesting price pressures remain firm.

Nevertheless, TD Securities expects only a modest increase in Eurozone inflation. The bank forecasts headline HICP at 2.9% year-over-year, up from 2.8%. At the same time, it expects core inflation to remain unchanged at 2.4%.

According to TD Securities, higher energy prices should support headline inflation. However, softer food and core goods prices are likely to offset part of that increase. Additionally, stronger airfare prices during the summer travel season could provide limited upside for services inflation.

If inflation exceeds expectations, traders may strengthen their bets on additional European Central Bank (ECB) rate hikes. Conversely, softer figures could reduce pressure for further policy tightening.

Key Eurozone Inflation Expectations

Bank of Japan’s Policy Framework

The Bank of Japan serves as the country’s central bank. Its primary objective is to maintain price stability while targeting inflation of around 2%.

Since 2013, the BoJ has relied on ultra-loose monetary policy to support economic growth and lift inflation. As part of that strategy, it introduced Quantitative and Qualitative Easing (QQE) and purchased large amounts of government and corporate bonds.

Later, in 2016, policymakers introduced negative interest rates and implemented yield curve control for 10-year Japanese government bonds. More recently, the BoJ began reversing that approach. In March 2024, it raised interest rates and started moving away from its ultra-accommodative policy stance.

How BoJ Policy Influences the Yen

Years of aggressive monetary stimulus weakened the Japanese Yen against most major currencies. Moreover, widening interest-rate differentials during 2022 and 2023 added further pressure as other central banks raised borrowing costs aggressively.

More recently, that trend has partially reversed. As the BoJ gradually normalizes policy, the Yen has recovered some of its previous losses.

Why the BoJ Is Tightening Policy

Several factors have encouraged the BoJ to begin normalizing monetary policy. A weaker Yen increased import costs, while higher global energy prices pushed inflation above the central bank’s 2% target.

In addition, stronger wage growth has improved the outlook for sustained inflation. As a result, policymakers now see room to gradually unwind years of ultra-loose monetary policy.