Will ECB show concern over EUR strength at today’s policy meeting?

EUR/JPY: Japan election risk & ECB policy meeting in focus

The yen has continued to trade at weaker levels overnight with USD/JPY briefly rising back above the 157.00-level. Renewed yen selling was reinforced yesterday by the release of another opinion poll from Japan indicating that the ruling coalition government is well on course to strengthen their majority in the Lower House. The latest Kyodo News survey revealed that the LDP has the upper hand in around 180 of the 289 single-member constituencies, compared with 138 that it held before the Lower House was dissolved. At the same time, the LDP is expected to win about 70 seats through proportional representation, under which 176 seats will be allocated based on the number of votes parties win in 11 regional blocks, compared with 60 that it held before the Lower House was dissolved. Together the LDP is on course to win around 250 seats out of the 465 seats in the Lower House. In contrast, the LDP’s coalition partner, Japan Innovation Party is expected to lose some of the 34 seats it held before the Lower House was dissolved. Kyodo News stated though that it would allow the ruling coalition to win 261 seats, and secure an “absolute stable majority” to control all 17 of the chamber’s standing committees. The survey results have reinforced market expectations that Prime Minister Takaichi will win a strong mandate to continue implementing her “reflationist” policy agenda providing a fresh catalyst for popular Takaishi trades encouraging further selling of the yen and JGBs. However, there was some good news for JGBs overnight. The latest 30-year JGB auction drew stronger demand. The bid-to-cover ratio rose to 3.64 which was higher than last month’s auction of 3.14 and the 12-month average of 3.35. Bloomberg has highlighted comments from the Meiji Yasuda Life Insurance Company stating that super-long JGBs offer attractive opportunities after the recent run up in yields, and they are looking for the right time to buy them potentially once political uncertainty has eased.   

Elsewhere, the euro has continued to correct lower against the US dollar ahead of today’s ECB policy meeting. After briefly hitting a high of 1.2081 last week, EUR/USD has dipped back below the 1.1800-level overnight. We are not expecting today’s ECB policy meeting to provide a fresh catalyst for euro performance in the near-term. The ECB are likely to reiterate that they are comfortable with their current policy stance but are unlikely to completely rule out the prospect of further easing. We expect the ECB to leave their policy rate on hold through 2026, but judge that there is a higher risk of another cut than a hike given inflation is likely to undershoot their target. Headline inflation slowed to 1.7% in January. A couple of ECB policymakers expressed some concern over euro strength last week when EUR/USD rose briefly above 1.2000, but we doubt that they will push back strongly at today’s policy meeting. The euro is only modestly stronger than at the last policy meeting in December although it has risen by around 14% against the US dollar over  the past year adding to disinflation pressures in the euro area. Governing Council member Francois Villeroy de Galhau stated last week that “we are closely monitoring this appreciation of the euro and its possible consequences in terms of lower inflation. This is one of the factors that will guide our monetary policy and our decisions on interest rates over the coming months”. We assume at best that the comments will put a dampener on further euro strength going forward. We continue to hold a long EUR/JPY trade recommendation (click here) but acknowledge that upside potential is currently being constrained by the heightened risk of intervention to support the yen.

SEK HAS STRENGTHENED SHARPLY ADDING TO DISINFLATION RISKS

Source: Bloomberg, Macrobond & MUFG GMR

SEK: Riksbank starts to indicate some concern over disinflation risks

After a strong start to this year, the Swedish krona suffered a setback yesterday triggered by the release of minutes from the last Riksbank policy meeting at the end of January. EUR/SEK has declined from close to the 11.000-level at the end of November and recently hit a low 10.501 at the start of this month, which was the lowest level since the summer of 2022. Over the past year, the krona has been the best performing G10 currency strengthening by around 21% against the US dollar and 7% against the euro. After such strong gains, the ongoing strength of the krona is starting to attract more concern amongst Swedish policymakers. Yesterday’s minutes revealed that Riksbank Deputy Governor Per Jansson couldn’t rule out voting for a rate cut at the next policy meeting on 18^th March. He was hesitant to propose a cut at the last meeting in January as he felt it would come as a major surprise to markets. He believes that inflation is falling faster than expected, and judges that the risks of inflationary pressures being too weak going forward have gradually increased in recent months. The strengthening krona plays into those disinflation risks in Sweden.

The dovish comments from the Deputy Governor have encouraged the Swedish rate market to price back in a higher likelihood of further rate cuts this year, and triggered a sharp correction lower for the krona. EUR/SEK jumped back above the 10.600-level. Overall, recent communication from the Riksbank still indicates that they are happy to leave rates on hold this year but the risk of further Riksbank easing if the krona continues to strengthen could help dampen further upside especially after the Deputy Governor indicated he is willing to vote for a cut as soon as the next policy meeting.

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com