EUR/JPY Bullish Outlook: Technical Analysis Points to Price Target of 161.00 Amid ECB Tightening and BoJ Dovishness

The global forex market continues to be shaped by diverging central bank policies, economic surprises, and geopolitical influences. Among the key currency pairs, EUR/JPY stands out, driven by stark contrasts between the European Central Bank (ECB) and the Bank of Japan (BoJ). This divergence creates both trading opportunities and risks, especially in a climate where inflation and post-pandemic recovery are at the forefront of economic strategies.

In this article, we explore the macroeconomic and technical aspects of EUR/JPY, providing expert insights into how traders can navigate the market amid the ongoing policy divergence between Europe and Japan.

Macroeconomic Analysis: The ECB vs. The BoJ

The driving force behind EUR/JPY movements lies in the vastly different approaches of the ECB and BoJ regarding monetary policy. The ECB has aggressively raised rates to combat high inflation, which remains a persistent issue despite signs of moderation. The ECB’s data-dependent stance suggests that further rate hikes are likely if inflation remains elevated. Eurozone inflation shows some deceleration, but not enough to shift the central bank’s hawkish tone.

Meanwhile, the BoJ has maintained its ultra-loose monetary policy through yield curve control. Despite inflation in Japan exceeding the central bank’s target, the BoJ has shown little inclination to tighten its policy, with Governor Kazuo Ueda signaling that rate hikes may not occur until 2024. Japan’s economic recovery is underway, but low inflation expectations and sluggish wage growth reduce the urgency for policy tightening.

Recent BoJ Decision: Steady as Expected

As widely anticipated, the Japanese central bank recently decided to leave interest rates unchanged, keeping its short-term interest rate target between 0.15% and 0.25%. The BoJ’s accompanying policy statement highlighted its expectation that Japan’s economy will grow above potential, with inflation likely aligning with the bank’s price target.

However, the decision offered little support for the Japanese Yen (JPY), as traders had already priced in this outcome. Despite this, hawkish expectations for future BoJ rate hikes remain a buffer for the Yen. Many traders expect the BoJ to hike rates in 2024, which is why the JPY maintains some resilience.

Following this decision, the EUR/JPY cross saw a mild decline, moving away from a two-week high. While BoJ’s inaction was expected, market sentiment surrounding future policy shifts kept the currency pair volatile.

Inflation and the Yen: What to Watch for in Japan

The latest data released on Japan’s Consumer Price Index (CPI) indicated a year-over-year rise to 3% in August, a 10-month high. The Core CPI, excluding volatile fresh food prices, also climbed to 2.8%, reflecting increased consumption driven by higher wages. Despite this uptick, the BoJ remains patient, choosing to focus on wage growth and sustained inflation before committing to any significant policy shift.

This persistent dovishness continues to weigh on the JPY, allowing the Euro (EUR) to maintain strength against the Yen, particularly as the ECB remains committed to its inflation-fighting efforts.

European Economic Outlook: Inflation and Stagnation

On the other side of the equation, Europe’s economic situation is challenging. While inflation remains high, economic stagnation is a growing concern, with fears of a recession looming. The ECB’s hawkish stance, aimed at curbing inflation, supports the Euro for now, but further economic slowdown could undermine this strength in the coming months.

The ECB’s recent decision to cut interest rates for the second time this cycle signals that the bank may see declining borrowing costs ahead. However, reports suggest that an October rate cut is unlikely, barring any significant deterioration in the economic outlook. These factors, combined with a bearish U.S. Dollar (USD), provide some support for the Euro, limiting downside risks for EUR/JPY.

Technical Analysis of EUR/JPY

From a technical perspective, EUR/JPY remains in a bullish trend on higher time frames (daily and weekly). The pair continues to respect an ascending trend line, which began in mid-August 2023, offering traders a strong foundation for upward momentum.

Key Levels to Watch:

• Support Level: 158.50 (previous swing low).
• Resistance Level: 161.20 (a major psychological level and recently tested resistance point).
• Fibonacci Levels: The 38.2% retracement level around 158.50 aligns with support, adding confidence to long positions around this zone.

Indicators:

• Moving Averages: The 50-day and 100-day moving averages remain bullishly aligned, signaling a continuation of the uptrend.
• Relative Strength Index (RSI): Currently at 65, indicating mildly overbought conditions but not yet signaling a reversal.
• MACD: The MACD shows a bullish crossover above the zero line, suggesting further upward momentum.

Geopolitical and External Factors

One cannot discuss EUR/JPY without acknowledging external geopolitical factors that affect both economies. Europe’s energy crisis remains a significant concern as winter approaches. While gas prices have somewhat stabilized, the region’s energy security is still fragile.

In Japan, global trade tensions, particularly between China and the U.S., present another risk. Japan’s heavy reliance on exports, especially to China, makes it vulnerable to shifts in global trade dynamics. Any escalation in trade tensions could weaken the JPY further, supporting EUR/JPY gains.

Risk Management and Trading Strategy

Given the potential for volatility driven by central bank meetings, traders should adopt a cautious approach to EUR/JPY. A robust risk management strategy is critical to navigating sudden shifts in sentiment.

Suggested Trading Approach:

• Entry Point: Consider entering long positions around 159.00, as the pair retraces slightly while respecting key support at 158.50.
• Take-Profit Target: A reasonable take-profit target would be around 161.00, just below the recent resistance level.
• Stop-Loss: Set a tight stop-loss at 158.30, slightly below the Fibonacci level and previous swing low to mitigate downside risk.

If the pair breaks below 158.30, consider shifting to a short position, with a target of 156.80, the next significant support level.

Quantitative Insights: Correlation and Volatility

Correlation analysis shows that EUR/JPY tends to correlate positively with major global equity markets, such as the DAX and Dow Jones. As risk appetite increases, the higher-yielding Euro benefits against the lower-yielding Yen. Additionally, current implied volatility for EUR/JPY options indicates moderate increases in volatility over the next two weeks, suggesting larger price swings ahead.

Long-Term Outlook: A Bullish Trajectory

The long-term outlook for EUR/JPY remains bullish, driven by continued monetary policy divergence. As long as the ECB remains focused on tightening and the BoJ sticks to its dovish approach, EUR/JPY could continue climbing toward the 162.00-165.00 range in the coming months. However, risks such as a deeper recession in Europe or a surprise policy shift by the BoJ could change the trajectory.

Conclusion: Navigating Divergence for Opportunity

The divergence between the ECB and BoJ presents a unique opportunity for forex traders. Understanding the macroeconomic landscape, analyzing technical indicators, and staying informed on geopolitical developments can provide traders with the insights needed to capitalize on movements in EUR/JPY. As always, maintaining a sound risk management strategy is essential when navigating the volatility of the forex market.

Disclaimer: This article is for educational purposes only and should not be considered financial advice. Always do your own research and consult a financial advisor before making any trading decisions.