Euro retreats from one-month top amid intervention risks, ahead of ECB

The EUR/JPY cross attracts some sellers after an intraday move up to a one-month high and drops to the 185.75-185.70 area during the early part of the European session on Wednesday. The supportive fundamental backdrop, however, favors bullish traders as the market focus remains on the crucial European Central Bank (ECB) meeting on Thursday.

In the meantime, expectations of a hawkish ECB tone might continue to underpin the shared currency and support the EUR/JPY cross amid the underlying bearish sentiment surrounding the Japanese Yen (JPY). In fact, investors are currently pricing in a 78% probability of an additional 25-basis-point (bps) ECB rate hike in September amid worries about energy-driven inflation. This would lift the ECB’s key deposit facility rate to 2.25%, which is significantly higher than the Bank of Japan’s (BoJ) policy rate of 1% – the highest since 1995.

Euro rate expectations seen capped despite upcoming ECB meeting

Analysts at ING caution that, even with focus intensifying on the upcoming ECB meeting and press conference, scope for a further hawkish repricing appears limited. As they note in their ECB cheat sheet, “it is hard to see the market pricing in even higher ECB rates, regardless of the language delivered at tomorrow’s ECB meeting and press conference,” suggesting that much of the tightening narrative may already be reflected in current market expectations.

Meanwhile, Bloomberg reported that the recent weakness in the Japanese Yen (JPY) poses an upside risk to Japan’s inflation, which should allow the BoJ to fasten its monetary tightening cycle. Adding to this, speculations that Japanese authorities will step in to prop up the domestic currency prompt some JPY short-covering and weigh on the EUR/JPY cross. However, the wide interest rate differential keeps the carry trade active and warrants caution for the JPY bulls.

Meanwhile, investors remain worried about economic risks stemming from the US-Iran standoff over the Strait of Hormuz as Japan relies on the critical waterway for over 90% of its crude oil imports. This might contribute to capping any meaningful JPY gains and validates the near-term positive outlook for the EUR/JPY cross. Hence, any meaningful corrective pullback might be seen as a buying opportunity and is more likely to remain limited.