The EUR/JPY is trying to recover from recent lows as worries about Japan’s finances weigh on the JPY. Right now, the pair is trading around 183.20, showing a slight gain of 0.06%. However, the recovery from the 182.00 level is slowing down. This rebound comes as fears of currency market intervention decrease, partly due to speculation about a possible cooperation between the Federal Reserve and the Bank of Japan. Despite this, concerns about Japan’s finances persist. Prime Minister Sanae Takaichi’s announcements about increased public spending and tax cuts keep downside risks for the JPY in check.

Challenges from Japanese Government Bond Yields

Japanese government bond yields are unpredictable due to these fiscal concerns, which adds pressure to the currency. A small drop in producer-side inflation aligns with the Bank of Japan’s decision to keep interest rates steady and its improved economic forecasts. The Euro (EUR) is getting limited support from recent Eurozone data, like the German business sentiment figures. Investors are now looking for insights from ECB President Christine Lagarde, who is expected to take a cautious stance without changing monetary policy. Given these factors, EUR/JPY remains stuck in a consolidation phase below recent highs, showing sensitivity to Japan’s political risks and central bank signals. The Euro is performing variably against major currencies, notably holding strong against the US Dollar.

Effects of Japan’s Loose Fiscal Policy

The key issue is the clash between Japan’s lax fiscal policy and the Bank of Japan’s slow approach to monetary tightening. With a snap election set for February 8, we anticipate increased volatility in the Japanese yen. This uncertainty makes long volatility strategies, like buying straddles on EUR/JPY, appealing for those looking to profit from a potential breakout without choosing a direction. We are closely monitoring Japan’s fiscal concerns because the country’s public debt is extremely high, currently over 260% of GDP. Prime Minister Takaichi’s plans for increased spending could drive Japanese government bond yields higher, which have already been fluctuating. This structural challenge for the yen suggests that any strength from central bank policies might be short-lived, favoring a slow rise in EUR/JPY in the medium term. However, we must also consider the Bank of Japan’s commitment to policy normalization, which has been in progress since they began unwinding stimulus measures in 2024. Traders remember last year’s sharp, intervention-driven rallies in the yen, making them cautious about aggressively shorting the currency. This situation may help support the yen and limit the immediate upside for EUR/JPY below its recent highs. On the Euro side, it lacks independent strength, with recent sentiment data, like the German IFO Business Climate index, showing a soft reading around 85.5. As the ECB is expected to hold steady, the EUR/JPY cross will likely respond mainly to yen-specific developments. Therefore, selling out-of-the-money call options to gather premium might be a good strategy, given that the pair may struggle to rise before the Japanese election. Considering these competing factors, one-month implied volatility for EUR/JPY is high, currently around 10.5%. This indicates that the market is preparing for a significant move, so we should focus on strategies that will benefit from either a sharp post-election breakout or the decay of options premium if the pair stays within a range. Watching the spread between German and Japanese 10-year bond yields will be crucial for predicting the pair’s next major movement. Create your live VT Markets account and start trading now.

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