Much of the thesis surrounding a strong euro and a strengthening Japanese yen in 2018 is built around central banks and expectations for monetary-policy normalization across the globe. This week will put this idea to the test, as both the European Central Bank and the Bank of Japan hold their first meetings of the year.
Analysts expect the ECB to pull back on its easy-money policies this year to play catch-up with the Federal Reserve, which has already increased interest rates five times since 2015. A hawkish ECB might provide a further fillip to the euro EURUSD, +0.3192% in 2018.
The Bank of Japan, meanwhile, is thought of as having the most accommodative monetary policy among its peers. Still, a decision to reduce its purchases of government bonds, also known as JGBs, earlier this month and comments about the negative effects of prolonged quantitative easing late last year, have analysts wondering when the BOJ will take action and push the yen USDJPY, -0.08% higher.
“Both the BOJ on Tuesday and the ECB on Thursday are likely to hold their monetary policies unchanged, but the yen and the euro could move sharply nonetheless in the event of verbal intervention from either central bank,” said Fawad Razaqzada, market analyst at Forex.com.
The BOJ’s policy decision is due Jan. 23, followed by the ECB on Jan. 25.
The BOJ’statement will also be accompanied by the central bank’s outlook report, which is the last one for Gov. Haruhiko Kuroda’s current term, said analysts from BNP Paribas, including Michael Sneyd. Kuroda could be reappointed for a second term.
A weaker yen would make sense given government bond yields of other developed nations are rising, the analysts added. Still, “we would highlight that the yen remains very cheap from a long-term valuation perspective and [currency] markets continue to price in BOJ policy remaining very dovish for the foreseeable future. In that respect, there is risk that, if Mr. Kuroda’s comments are seen as signaling a less dovish trajectory ahead, the yen could strengthen.”
Earlier this month, the BOJ opted to reduce the amount of government paper it buys through its quantitative-easing program, which made both the yen and yields on JGBs jump.
Read: Relax, the Bank of Japan isn’t tapering—yet!
It “jolted the markets earlier this month, particularly since the general consensus had been that the BOJ was in [easy-money mode] for the long haul,” wrote Michael Hewson, chief market analyst at CMC Markets U.K. “This month’s actions have shown that can’t be taken for granted, so markets will be paying close attention to not only what Kuroda does, but also how [he] guides future expectations of policy moves later on into 2018.”
Back in Europe, expectations for the ECB to change its tone to a becoming more hawkish have mounted recently since the central bank released the minutes of its December meeting.
As per the minutes, policy makers think they could revisit their policy stances early this year—which could already mean this week—despite their continued concerns about low inflation, and occasional discomfort over a strengthening euro.
The ECB began to scale back the size of its monthly bond purchases to €30 billion ($36.7 billion) a month starting this month from the current pace of €60 billion, to be continued until at least September.
After the euphoria that followed the ECB’s December minutes, propelling the euro higher, traders could be disappointed should the central bank’s boss Mario Draghi adopt a more dovish stance than anticipated this week, thereby leading to a euro slump.
“We expect the ECB to wait until March before shifting policy, but Draghi’s euro remarks will be scrutinized heavily,” wrote BMO’s European head of FX strategy Stephen Gallo.
“We believe that market participants solely positioned for a tighter rate differential between the Federal Reserve and the ECB could become disillusioned with the euro in 2018,” said Wells Fargo analysts including investment strategist Peter Donisanu.
If expectations have moved too much too fast, the euro could drop to $1.21, according to the BNP analysts. One euro last bought $1.2246 on Friday.