Yen sell-off continues as BoJ leaves monetary policy unchanged last Friday.

JPY: BoJ stands pat as policy divergence widens.

During the Asian trading session on last Friday, the yen has continued to trade at weaker levels, following the recent policy update by the Bank of Japan (BoJ). This month, the yen has experienced a significant decline in value due to expectations of a growing divergence in monetary policies between the BoJ and other major central banks. As a result, the yen has fallen below its lowest point from September of last year when compared to a basket of other G10 currencies. Against all other G10 currencies, the yen has weakened by over 3.0% this month, except for the US dollar, where the losses have been relatively more modest, around 1.0%.

Among the yen crosses, the best performers have been AUD/JPY (+7.0%), NOK/JPY (6.5%), and NZD/JPY (+4.7%). This yen weakness can be attributed to a combination of factors, including improving global investor risk sentiment, decreasing foreign exchange volatility, and the increasing divergence in monetary policies between the BoJ and other major central banks. The recent policy update by the BoJ did not disrupt the ongoing trend of yen depreciation, as they decided to maintain their loose monetary policy conditions.

JPY HITS FRESH COVID LOWS

Source: Bloomberg, Macrobond & MUFG GMR

This situation contrasts with the recent trend of unexpectedly hawkish policy decisions made this month by the Reserve Bank of Australia (RBA), Bank of Canada (BoC), Federal Reserve (Fed), and the European Central Bank (ECB), which have resulted in increased yields outside of Japan, approaching the year-to-date highs. Therefore, the growing disparity in yield spreads between Japan and other countries, coupled with reduced foreign exchange and interest rate volatility, is making carry trades funded by the yen more appealing. This, in turn, is contributing to the yen becoming significantly undervalued.

EUR: Hawkish ECB policy reinforces recent rebound for Euro.

The Euro received a boost on Friday from the European Central Bank's (ECB) hawkish policy update, resulting in EUR/USD climbing above 1.0950 and surpassing last month's low of 1.0635. Similarly, EUR/JPY experienced a significant surge, reaching the 154.00-level not seen since the collapse of Lehman Brothers in September 2008 when the unwind of yen-funded carry trades was at its peak. As anticipated, the ECB raised rates by another 25bps, pushing the deposit rate to 3.50%. The most surprising aspect of the policy update was the revised guidance, clearly signalling the likelihood of another rate increase at the upcoming July meeting. ECB President Lagarde emphasized that the Governing Council has not considered pausing or skipping the rate hike cycle, countering speculations of an imminent end to the cycle. This aligns with my forecast of an additional 25bps hike in July, increasing the probability of a final 25bps hike in September, potentially bringing the deposit rate closer to 4.00%.

When determining monetary policy, the ECB is placing greater emphasis on the outlook for core inflation. President Lagarde expressed dissatisfaction with the inflation outlook, indicating a need for further policy tightening. Although core inflation has recently eased to 5.3% in May from its peak of 5.7% in March, it is expected to rebound during the summer months. Changes in index weights, including increased contributions from travel-related services, and base effects from last year's cheaper public transport program in Germany, are likely to drive this rebound in core inflation, particularly during the tourism high season. However, clear evidence of core inflation heading downward may not emerge until autumn or later.

The upward revision of the ECB staff's latest core inflation forecasts has heightened the Governing Council's concerns about the risk of persistent inflation overshoot. Forecasts for core inflation were significantly revised upward by 0.5 percentage points for both this year and next, reaching 5.1% and 3.0% respectively. The forecast for 2025 saw a slight increase of 0.1 percentage point to 2.3%. These revisions to core inflation outweighed the minor downward adjustments to the Eurozone's growth outlook. GDP forecasts for this year and next were marginally reduced by 0.1 percentage points to 0.9% and 1.5% respectively. President Lagarde did not appear overly worried about the Eurozone economy falling into a technical recession at the beginning of this year, and although activity remains weak in Q2, she remains cautiously optimistic.

This content may have been written by a third party. ACY makes no representation or warranty and assumes no liability as to the accuracy or completeness of the information provided, nor any loss arising from any investment based on a recommendation, forecast or other information supplied by any third-party. This content is information only, and does not constitute financial, investment or other advice on which you can rely.