The EUR/JPY pair has hit a new yearly high, staying above 173.00 during the American session. The Yen is under pressure from large interest rate differences, inflation driven by imports, and political uncertainties. In May, Eurozone industrial production recovered strongly, rising 1.7% from the previous month and 3.7% year-over-year. The Euro is gaining against the Yen, as the Yen struggles with interest rate gaps and inflation pressures.

Bank of Japan’s Caution

The Bank of Japan is cautious about raising interest rates, even though inflation is above the 2% target. Political uncertainty ahead of the July 20 Upper House elections is adding pressure, as polls indicate potential losses for the ruling coalition. Concerns about fiscal policy and possible increased government spending after the elections are affecting market sentiment, continuing to weigh on the Yen. Meanwhile, Eurozone industrial activity is bouncing back, with a 1.7% production increase in May and economic sentiment slightly rising to 36.1 in July. Technical charts show a bullish trend for EUR/JPY near 173.00, with strong momentum indicated by a high Average Directional Index. However, the Relative Strength Index shows overbought conditions, which may lead to a short-term pullback.

Fundamental Divergence Between Monetary Policies

The key driver of this trend is the clear difference in monetary policies. The interest rate gap is wide, with the European Central Bank holding its main rate at 4.50% while Japan’s is close to zero. This creates a tough environment for holding Yen, providing a significant boost for the Euro. Additionally, Japan’s core inflation was 2.5% in May, staying above the 2% target and highlighting the reluctance to adjust policies, which affects the Yen’s value. This situation is not only about monetary policy but also politics. Prime Minister Kishida’s administration is facing instability, with approval ratings dropping below 20% in some polls. This uncertainty makes market participants wary, causing them to sell the currency linked to it. The rebound in Eurozone industrial numbers adds justification for favoring the Euro. Traders using derivatives in this environment should find a mix of boldness and caution. The high directional index indicates a trend that should be followed, not opposed. Buying call options on EUR/JPY is a direct way to express this bullish outlook, allowing for leveraged gains while controlling risk to the premium paid. We suggest looking at out-of-the-money calls with expirations in the next few months to take advantage of the strong momentum. That said, the indication of overbought conditions should not be overlooked. A significant short-term pullback is possible. To manage this risk, a bull call spread—buying one call and selling a higher-strike call—is advisable. This strategy reduces upfront costs and aims to profit from further increases, though at a more measured pace. One notable risk is intervention. Sharp Yen rallies earlier this year were linked to possible official actions against the dollar. Japanese authorities can intervene unexpectedly to counter excessive currency weakness. Therefore, selling naked puts is a risky strategy. Instead, traders who believe that support near 173.00 will hold might consider a put credit spread, which defines risk while allowing them to profit if the pair remains above a certain level by expiration. This approach recognizes the potential for a dip but bets against a complete trend collapse. Create your live VT Markets account and start trading now.

here to set up a live account on VT Markets now