EUR/JPY traded near 186.95 on Monday, up 0.07%, as markets waited for policy decisions from the Bank of Japan (BoJ) and the European Central Bank (ECB).
The BoJ is expected to keep its rate at 0.75% on Tuesday. Attention is on its messaging and whether it points to a possible June rate rise.
Central Bank Focus This Week
The ECB is expected to leave policy unchanged on Thursday, with the deposit rate at 2%. The bank is waiting for more data amid uncertainty linked to the Middle East conflict.
In Germany, the GfK Consumer Confidence index fell to -33.3 for May, the lowest in more than three years. The Euro’s reaction has been limited so far.
Middle East developments remain a main driver for markets, with talk of de-escalation after reports that Iran sent a new peace proposal to the US. Talks are still stalled, oil tankers have been blocked for two months, and crude prices are near $100 per barrel.
Safe-haven demand and energy-led inflation expectations are affecting the Yen. The Euro is constrained by weak growth and limited visibility on policy, with EUR/JPY guided by central bank signals and geopolitical news.
Options Market Signals
With major central bank decisions this week, we see implied volatility in EUR/JPY options ticking higher. One-week volatility has climbed to 11.5%, a sharp increase from the monthly average, showing that the market is bracing for a significant price move. This suggests traders are positioning for a breakout from the current tight range around 187.00.
We are watching the Bank of Japan very closely, as its forward guidance will be the main driver for the Yen. While a rate hold at 0.75% is priced in, Japan’s core inflation has remained stubbornly above target, clocking in at 2.8% for March, fueling speculation of a summer rate hike. This situation, a major shift from the negative rates we saw back in early 2024, makes buying short-dated EUR/JPY put options an attractive strategy to protect against a hawkish surprise.
In Europe, the picture is one of stagflationary risk, which ties the European Central Bank’s hands. The plunge in German consumer confidence to a three-year low is deeply concerning, and the latest Eurozone manufacturing PMI of 48.5 marks the fifth straight quarter of contraction. This economic weakness makes it difficult for the ECB to fight the inflation being imported by high energy costs, capping the Euro’s potential.
The overarching issue is the geopolitical tension keeping oil prices near $100 per barrel, a situation reminiscent of the energy shock we experienced in 2022. Global supply chains are strained, with shipping costs having tripled over the past two months. This sustained pressure fuels recession fears and makes long positions in volatility indices or call options on energy sector ETFs a sensible hedge against further escalation.
Given these conflicting drivers, we believe outright directional bets are risky. A better approach for the coming weeks could be to use options to structure a long strangle on EUR/JPY, which would profit from a large move in either direction following the central bank announcements. This strategy allows us to capitalize on the rising volatility without having to predict the complex interplay between a cautious ECB and a potentially hawkish BoJ.
