Tuesday, July 14, 2020

Can EUR/JPY continues to rise as the ECB and BoJ decides on monetary policies this week?

  • Yen
  • Euro
  • European Central Bank
  • Bank of Japan


Analysts’ Pick: Can EUR/JPY continues to rise as the ECB and BoJ decides on monetary policies this week?

  • Both the BoJ and ECB are likely to keep monetary policy on hold as the immediate impact of the Covid-19 pandemic eases
  • BoJ will probably remain dovish as its domestic economic outlook remains weak and to prevent the yen from strengthening
  • There may be some cautious optimism warranted for ECB policy makers as the EU bloc continues to remain on pace for recovery
  • EUR/JPY’s outlook for the week remains tilted to the upside but downside risks, if materialised, may put upward pressure for safe haven currencies

The Bank of Japan (BoJ) is set to decide on monetary policy tomorrow, with the announcement of its decision after its meeting at around 11am (GMT +8). But it looks like there may only be a low likelihood for changes to its current tools if any. The central bank has shown reluctance to cut rates deeper into negative territory, and its incentive to ease further via interest rates cuts is unlikely as well, given that the Dollar Yen has managed to stay above 106.00's level since its last meeting. Also, cutting interest rates is unlikely to be as effective given the current environment, since household spending is unlikely to be strongly driven by lower interest rates.

The Japanese yen has managed to retain its level after a sharp spike in demand for safe haven assets in early March


Little action is needed for its corporate bonds and commercial paper purchase program as well as its holdings for both are still less than half of their respective limits. Given that the bank tripled the ceilings for its corporate bonds and commercial paper holdings in April to help mitigate the pandemic's impact on the Japanese economy and both holdings still have a large headroom before reaching the specified limits, it is unlikely that the central bank will increase the limits any more during tomorrow's meeting.

The BoJ still has a large surplus before its corporate bonds and commercial paper purchase programs reach their limits


However, the BoJ is still likely to remain dovish on its statement, as the Japanese economy remains weak. With exports continuing to fall in May while consumer confidence remains low, the outlook for Japan's economy looks bleak. This means that consumer spending is likely to continue to remain weak domestically, possibly continuing to fall from May, but at a slower rate than before. PMI data remains weak as well, despite improving from May with both manufacturing and services activity in the Japanese economy contracting in June.

With exports continuing to fall and consumer confidence recovering slowly, the outlook for the Japanese economy remains weak


Hence, the BoJ is likely to keep monetary policy on hold while assessing the current economic conditions as well as adjust its economic outlook. Risks regarding US-China relations as well as the resurgence in Covid-19 infections also suggests that the BoJ is likely to keep its dovish tone to curb more strength for the yen which would consequently put even more downward pressure on its exports. As a result, the yen looks likely to fall following the post-monetary policy meeting press conference by BoJ Governor Haruhiko Kuroda.

Overnight Index Swaps implied probability of -31.3% signals that expectations for a rate cut from the BoJ remains low


Similarly, we expect little changes to the European Central Bank's (ECB) monetary policy tools at its meeting on Thursday. The EU bloc has managed to maintain containment of the novel coronavirus following the various degrees of outbreak across its member countries. Economic data signals that the bloc is now moving towards a recovery phase is likely to help with optimism among central bankers as well. Retail sales and employment data has shown improvements starting from May, beating economists’ estimates. PMI data has improved in June as well, signalling that the overall European economy has started to recover from the imposed lockdowns earlier in the year. While data does show improvements, it is important to note that it remains week in comparison to previous years' data.

Containment of Covid-19 cases in the EU remains more successful in comparison to the US


Economic data in the EU has shown that the bloc is starting to show signs of recovery


The ECB also has little incentive to increase asset purchases as its programs still has more room to expand before reaching its limits. The central bank's Pandemic Emergency Purchase Programme (PEPP) still has more than enough headroom (close to 1 trillion euros in excess) to continue at its current pace into early next year.

The improving economic data will likely call for some optimism among policymakers in the ECB, but it will likely only be cautious optimism as the central bank will probably note the resurgence of Covid-19 infections in other parts of the world as a growing risk for the bloc itself. Inflation also continues to remain low and will likely continue to be impacted by low oil prices despite crude oil's recovery in May. We hence expect the central bank to remain on hold with its current monetary policy tools, with ECB President Christine Lagarde expressing some cautious optimism during her press conference following the monetary policy meeting. Lagarde is also likely to highlight that risks continue to tilt towards the downside during her speech. The euro may likely experience some slight upward pressure as a result of some optimism from the ECB.

Overnight Index Swaps tracking the ECB’s decision this week suggests that there is little to no expectations for a rate cut or hike by the central bank


EUR/JPY's outlook for the week is likely tilted towards the upside as a result. The currency pair may trend higher on the BoJ's monetary policy announcement, possibly breaking 121.91's level to rise closer towards 122.49. If the ECB shows hints of optimism, then EUR/JPY may likely strengthen and rise to 122.49's along the week as well. Downside risks that may put downward pressure on the currency pair may stem from resurgence in Covid-19 infections in the EU, as well as possibly strong demand for safe haven assets in the event that this week's corporate earnings are much weaker-than-expected, or US-China relations escalate further this week.

Technical Analysis:


The euro-yen currency pair is currently on an uptrend and looks likely to continue on its current trajectory as the outlook for the EU’s post-pandemic recovery phase remains brighter compared to the US. The 200-day moving average has provided a strong support in previous weeks and looks likely to continue in the medium-term. This week’s fundamentals may skew the currency pair towards the upside in the short-term but opposing risks suggests that there may be room to fall as safe haven demand picks up. We expect the overall outlook for the euro-yen pair to be positive, and trend back towards the 122.49’s level over the week. There may be some slight regression towards the 20-day moving average near 121.18, but it looks likely to be temporary. With the currency pair now trading at the 23.6% Fibonacci retracement level, we may see a breakthrough for the bulls and possibly push EUR/JPY past the resistance at 121.91 as well. If downside risks materialise, EUR/JPY may fall towards the 200-day moving average.

Support: 121.18 / 120.47 / 119.40

Resistance:  121.91 / 122.49 / 123.95

EUR/JPY Chart (H4)