EUR/JPY outlook positive despite pullback

The EUR/JPY eased off around 70 pips on the session, after reaching its highest level since 2014 on Monday. On Tuesday, it fell back because of 1) a mild sell-off in risk-sensitive assets; 2) a drop in global bond yields, boosting the appeal of the lower-yielding yen; 3) stronger-than-expected Japanese CPI data (2.9% vs. 2.6% expected), and 4) profit-taking ahead of the BoJ rate decision. But thanks to a hawkish ECB and a still-dovish BoJ, we maintain a bullish longer-term EUR/JPY outlook and reckon 150.00 is not out of reach.

Risk off weighs on EUR/JPY

Risk appetite soured in the first half of Tuesday’s session as shares in UBS fell to trigger a sell-off in European markets, while mostly positive earnings on Wall Street failed to lift US futures. The not-so-positive reaction in the equity markets weighed on risk-sensitive currency pairs, including the AUD/USD, EUR/JPY and GBP/USD. As the US dollar rebounded, down went metal prices, led by a 3% drop in palladium, while copper (-2.5%) and silver (-2.3%) also experienced sharp falls.

The EUR/USD was clinging onto the 1.10 handle at the time of writing. But it looked vulnerable amid the general dollar strength. That said, we maintain our longer-term bullish view on the EUR/USD as the ECB seems determined to remain on a hawkish path.

However, in the short-term, thanks to the rebound in USD and ahead of key US data releases this week, we wouldn’t rule out some pullback/consolidation in the EUR/USD exchange rate. Consequently, we prefer to concentrate on euro crosses in this market environment. The EUR/JPY comes to mind.

Why has the euro been rising?

In short, because of continued hawkish talk by ECB officials as inflation remains uncomfortably high.

CPI in the region cooled in March to 6.9% YoY from 8.5% the month before. But at 3.5 times the ECB’s target, it is just too high to ease off the gas just yet. What’s more, core inflation is at a record high. The ECB is thus very likely to raise rates for a seventh consecutive time at its meeting on May 4, by at least 25 basis points.

French ECB policymaker Francois Villeroy de Galhau on Monday said that “there may be a need for a few more hikes…[as] neither inflation excluding energy and food nor broader underlying indicators show clear and convergent signs of a change in the trend. However, he added that they should be limited in number and now in size. This is because “most of the future impact on the economy is due to what is already in the pipeline, so we have travelled most of the way.”

Others, such as Gabriel Makhlouf have said similar things in recent days i.e., that pausing the tightening campaign would be a premature move. “Indeed, and again based on the evidence we have to-date, rates will need to continue at restrictive levels to help reset the balance between supply and demand in the economy and bring down inflation.” 

ECB Chief Economist Philip Lane said that “this is still not the right time to stop. Beyond that, I don’t have a crystal ball; it will depend on the economic data.”

Several other ECB officials also echo this sentiment, while some, like Isabel Schnabel, are even more hawkish. The latter said a 50 bp rate hike was not off the table.

Indeed, the market odds of 25 basis point hike is above 50%, and there’s a 1 in 3 chance of a larger 50 bp hike.

Ueda will disappoint policy change expectations

Friday’s Bank of Japan meeting will be the first under the leadership of the new Bank of Japan Governor, Kazuo Ueda. Given that Ueda has already mentioned that he will continue with the BOJ's current policy stance, the yen struggled to find much love in recent days. While we would be mindful of a potential surprise with regards to the BoJ’s yield curve control (YCC) settings, we highly doubt that any changes will be announced at this particular meeting. That said, any policy changes would likely trigger a sharp rally in the yen and a sell-off in yen crosses like USD/JPY and AUD/JPY.

One reason why the BOJ might avoid altering its policy is concerns about Japan returning to deflation. This means it may postpone any plans to change the YCC policy until next year – which is why our EUR/JPY outlook remains bullish.

EUR/JPY outlook: More gains likely

On Monday, the EUR/JPY extended its rally to its highest level since 2014, before a combination of profit-taking and slight risk aversion caused it to fall back. I reckon the EUR/JPY is still heading towards 150.00, thanks to the ever-increasing divergence between European and Japanese monetary policy divergence.

So, while some short-term weakness should be expected after an extended run, and a potential false breakout technical reversal pattern, be on the lookout for fresh bullish signals to emerge, which could precede a fresh rally to a new multi-year high.

The EUR/JPY was actually testing a potential level of support around 147.50-147.55 area at the time of writing, which meant there was a slim chance for a rebound heading deeper into Tuesday’s session. This area was the high of Friday’s range, when it formed a bullish hammer candle. With rates extending higher on Monday, dip-buyers might step in here to provide support, if sentiment improves towards risk assets later.

EUR/JPY traders should be watching price action closely on the smaller time frames to spot any potential bullish opportunities.

If we don’t see that confirmation, then the bulls must remain patient as the weakness could extend for a bit longer.

 Source: TradingView.com