The yen remains a popular currency in the forex markets for many reasons and in this case, it is because of its attractiveness in the “carry trade”. A carry trade exists whenever you have two currencies with diverging interest rate spreads i.e. one stays low while the other increases. This To allows a process by which funds are borrowed in the currency charging the lowest rate with the intention of convertthese fundsat invest in a currency offering the higher rate of return.
With interest rates in negative territory since 2016, the Japanese yen is once again emerging as a suitable “funding” currency. While most developed countries grapple with searing inflation at decades-long highs, Japan continues to struggle to achieve higher inflation over the long term, firmly entrenching its negative interest rate regime.
The British pound has become an appropriate counterpart to the yen, as expectations of interest rate hikes have already gained ground in November 2021. With the threat of escalating inflation, the rebound in the UK economy and reasonable employment data after the end of the Coronavirus Job Retention Scheme, the Bank of England (BoE) decided to raise interest rates by 0.15% to end 2021 to 0.25%.
Since the December central bank meetings, the pace of implicit market rate hikes for the pound sterling is currently exceeding that of the United States. Although these indications are far from perfect as the global macroeconomic environment becomes increasingly responsive to developments around the coronavirus and the variants that may emerge. Such shocks are likely to cause implicit market rates to fluctuate drastically.
Implied interest rate hikes (GBP vs USD) highlighting March 2022
It should be noted that a possible headwind for the British pound appeared in mid-December when Boris Johnson’s Conservative Party lost a seat in parliament in North Shropshire, a region which has supported the Tories for nearly 200 years. While a seat out of the 650 occupied by the Tories doesn’t seem like a big deal, the result has been seen as an indictment against Johnson’s leadership over recent failures. The Conservative Party is no stranger to the leaders’ recall and doubts have surfaced over Johnson’s future as party leader and as UK Prime Minister which could weigh on the pound.
Technically, GBP / JPY previously attempted to break above the 2018 high before reversing sharply towards the support area between 148.50 and 149.50. The last three quarters of 2021 saw higher highs as lows remained anchored around the support area, without reaching lower lows.
Therefore, a test and rebound on the support area could provide a launching pad for another test of the 2018 high at 156.60 with the closest resistance level appearing at 153.50.
GBP / JPY weekly chart
Source: IG, prepared by Richard Snow
The GBP / JPY daily chart shows how the pair approached the 2018 high just before the Monetary Policy Committee (MPC) met on November 4.e, which ultimately resulted in a somewhat surprising decision to leave rates unchanged despite a built-in rate hike. The sharp decline was further amplified by the emergence of the Omicron variant, once again leading to relatively lower prices hovering around the support area.
Fast forward to today and Omicron fears have dissipated significantly and we have just witnessed the first rate hike in the UK since the pandemic. Therefore, just like before the November meeting, markets could start to assess pending further increases that could boost GBP / JPY in the first quarter of next year.
GBP / JPY daily chart
Source: IG, prepared by Richard Snow
— Written by Richard Snow