EUR/JPY retreats further from multi-year peak, downside potential seems limited

• EUR/JPY edges lower for the second successive day on Monday, albeit lacks follow-through.
• Reviving safe-haven demand, along with intervention fears, benefit the JPY and exert pressure.
• The divergent BoJ-ECB policy stance favours bullish traders and should help limit the downside.

The EUR/JPY cross kicks off the new week on a softer note and moves further await from its highest level since September 2008, around the 159.20 region touched on Friday. Spot prices drop to the 158.25 region during the Asian session, down for the second straight day, though any meaningful corrective decline still seems elusive.

Speculations that the recent weakness in the Japanese Yen (JPY) might prompt some jawboning from authorities or even lead to an intervention in the foreign exchange markets turn out to be a key factor acting as a headwind for the EUR/JPY cross. Apart from this, a generally weaker tone around the Asian equity markets benefits the safe-haven JPY and exerts some downward pressure on spot prices. Against the backdrop of growing concerns about the worsening economic conditions in China and US-China tensions, geopolitical risks temper investors’ appetite for riskier assets and drive some haven flows towards the JPY.

It is worth recalling that US President Joe Biden last week signed an executive order, which prohibits new US investment in China in sensitive technologies like computer chips and requires government notification in other tech sectors. Adding to this, Taiwan Vice President William Lai left on Saturday for a sensitive trip to the US, which China has condemned. Furthermore, Taiwanese officials fear that the trip could prompt more Chinese military activity around the democratically governed island. Meanwhile, China’s Commerce Ministry announced an anti-dumping tariff for polycarbonate imported from Taiwan effective from August 15.

On the geopolitical front, the Russian warship fired warning shots at a cargo ship in the southwestern Black Sea on Sunday and further tempers investors’ appetite for riskier assets. That said, the Bank of Japan’s (BoJ) dovish stance might keep a lid on any further gains for the JPY and helps limit the downside for the EUR/JPY cross, at least for the time being. In fact, policymakers have stressed that steps taken in July to make the BoJ’s Yield Curve Control (YCC) policy more flexible and allow yield on the 10-year Japanese government bond to move up toward 1% was a technical tweak aimed at extending the shelf life of stimulus.

In contrast, the European Central Bank (ECB) has raised borrowing costs by a combined 425 bps since last July. Moreover, the markets are still pricing in a greater chance of one more rate hike by the end of this year. This marks a big divergence in the monetary policy stance adopted by the two major central banks and supports prospects for the emergence of some dip-buying around the EUR/JPY cross. Hence, it will be prudent to wait for strong follow-through selling before confirming that spot prices have topped out in the near term and positioning for any meaningful corrective pullback.

Technical levels to watch