EUR/JPY rose for a third straight session, trading near 185.30 in early European dealings on Wednesday, as the Euro drew support from expectations the European Central Bank will tighten policy at its June meeting on Thursday. Markets are pricing a 25 basis-point increase in the ECB’s key rates. The central bank’s mandate is price stability, targeting inflation of around 2%, with rate policy set by the Governing Council at eight meetings a year.
The Yen lagged even after Japan’s Producer Price Index accelerated, with PPI up 6.3% year on year in May, compared with April’s upwardly revised 5.3% and above the 5.5% consensus, the quickest wholesale inflation in three years. That has reinforced expectations of a more hawkish Bank of Japan, with markets looking for a rate rise at next week’s meeting. Separately, the ECB can deploy Quantitative Easing, used in 2009-11, in 2015, and during the covid pandemic, while Quantitative Tightening reverses QE by halting additional bond purchases and ending reinvestment of maturing principal.
ECB Forward Guidance In Focus Amid Rate Hike Expectations
With the EUR/JPY cross trading at multi-year highs near 185.30, we see the immediate risk centered on tomorrow’s European Central Bank meeting. A 25 basis point rate hike is almost entirely priced into the market, meaning the Euro’s reaction will depend more on the forward guidance. We must watch for any signals that the ECB is nearing the end of its tightening cycle.
Recent Eurostat figures showing core inflation remains sticky at 2.9% justify the ECB’s hawkish stance, but this is already known. Therefore, we are positioning for volatility around the press conference rather than the rate decision itself. Any hint of a pause in future hikes from President Lagarde could trigger a pullback in the Euro, as the market is currently positioned for continued strength.
BoJ Policy Pivot and EUR/JPY Volatility Trading Strategies
The bigger opportunity, however, lies with the Bank of Japan’s meeting next week. Japan’s shockingly high 6.3% producer price inflation increases pressure on the BoJ to abandon its ultra-loose policy. Historically, the BoJ has been extremely cautious, which makes the market’s aggressive pricing for multiple rate hikes this year a source of major instability.
Given this tension, we believe taking an outright directional view is too risky. Instead, we should consider buying volatility, as a significant price swing is likely regardless of the BoJ’s decision. We have seen implied volatility on one-week EUR/JPY options jump to over 12%, suggesting the market is bracing for a powerful move.
This setup is a classic carry trade scenario, where traders have profited from borrowing the low-yielding Yen to buy the higher-yielding Euro. A hawkish surprise from the BoJ could trigger a violent unwinding of these positions, causing a rapid appreciation in the Yen and a sharp fall in EUR/JPY. Historically, such reversals, like those seen in past financial cycles, can erase weeks of gains in just a few days.
For traders who believe a BoJ pivot is imminent, we suggest buying out-of-the-money put options on EUR/JPY. This strategy provides a low-cost way to position for a significant downside move. It effectively creates a leveraged bet on a stronger Yen while strictly defining the maximum potential loss to the premium paid for the option.
