BOJ and EU CPI to Move EURJPY

After the ECB kept rates steady, the BOJ is under increasing pressure to normalise policy, which could finally bring the EURJPY off its summer plateau.

Pause to Save the Economy?

Last week, the ECB declined to raise rates as the shared economy is facing troubled economic times, and some analysts speculate that the aggressive rate hiking is the cause of stagnation. The silver lining for the ECB is that slower economic activity typically translates into inflation coming down.

CPI figures over the coming days are expected to justify the ECB stepping back from tightening, with German inflation coming down to 4.0% annualised in the preliminary reading for October. That is below the 4.5% reported in September. French inflation will be reported tomorrow and is expected to come down to 4.1% from 4.9% previously, which would lead to the expectations for a dramatic drop in Eurozone headline inflation to 3.3% from 4.3%. Core inflation is expected to be slightly more elevated at 4.3% compared to 4.5% prior. But the trend could suggest that tightening is over, and the euro could drift lower.

Pressure Mounts to Support the Yen

Also, tomorrow is the BOJ's rate decision, where analysts are comfortable to expect no tightening. But, after the abrupt rise in the Tokyo CPI reported last week, there is increased speculation that the BOJ could adjust its yield curve control (YCC) mechanism again. This supported yields, which rose to the highest they've been in 10 years earlier this morning.

The BOJ could consider shifting the range of YCC bands up by 0.5bps or moving the reference from the current 10-year to the 5-year bond. Both would allow for yields to rise and presumably strengthen the yen. The currency's weakness drives inflation higher but also supports the economy, which leaves the BOJ in a predicament of which aspect to prioritise. The BOJ will also issue its quarterly forecast update, with the potential to raise its inflation expectations for next year. Currently, the BOJ expects inflation to come back to 1.9% (below its 2.0% target), which justifies its lack of move towards tightening. But, if inflation expectations are revised upwards and above the target, traders might speculate it's a signal that the BOJ will move towards tightening.

With the ECB expected to hold rates steady for a long time and the BOJ potentially moving to hike, the EURJPY pair could see the yield gap start to shrink and get some downward pressure.

EUR/JPY Tops After Flag Pattern

The pair failed to hit 160 and reversed prematurely, rising speculation for additional drops towards 154.40 should 157 and 156 give way to bears. The double-top formation may come under scrutiny if bulls reclaim 159 though following the completion of a flag pattern, with a fresh high towards 161 seen as the next stop.

Source: SpreadEx / EURJPY

Key Takeaways

After the ECB decided not to hold, there is speculation that the BOJ may face pressure to normalise its policy, leading to a potential shift in the EURJPY. Slower economic activity could lower inflation, which might justify the ECB's decision to step back from tightening. CPI figures are expected to show a decrease in inflation rates in Germany and France, which could contribute to a drop in Eurozone headline inflation. On the other hand, the BOJ's rate decision is anticipated to involve no tightening, but recent CPI data has raised speculation that the BOJ may adjust its yield curve control mechanism by widening the YCC band or changing the reference bond duration. With the ECB holding rates steady and the BOJ potentially moving towards tightening, the EURJPY pair could experience downward pressure as the yield gap narrows.