Market News

BY  Yumi Teso and Daisuke Sakai, Bloomberg News

, Bloomberg

(Bloomberg) -- The yen is sliding faster against the euro than the dollar as speculation grows that the European Central Bank will take it slow in cutting interest rates because inflation remains elevated.

The Japanese currency has weakened 1.3% against the euro this month and is approaching its previous record low of 171.56 reached on April 29. While the Bank of Japan ended the world’s last negative interest rate policy in March, its rate gap with overseas counterparts including the European Central Bank remains wide. 

There has been some disagreement on the pace of likely moves among ECB members that has fueled investor expectations that changes will be gradual. Meanwhile, the UK pound climbed to the highest level against the yen since 2008 on the view that the Bank of England will also take its time due to lingering inflation.

The yen has weakened to 34-year lows this year against the dollar, but the risk of intervention by Japanese authorities to support the currency has caused the decline to slow. Japan is suspected to have bought yen for dollars in late April and early May. 

The Japanese currency briefly spiked on Wednesday after BOJ policy board member Seiji Adachi acknowledged it’s possible that yen weakness could spur price gains and prompt authorities to consider another rate hike earlier than expected. The fact that even Adachi, a noted dove on the board, hinted at more policy action bolstered expectations that an additional interest-rate hike is in the works. 

Recent low volatility adds to headwinds for the yen because it will encourage investors to borrow more in the currency cheaply to invest in higher-yielding assets abroad, in a popular transaction called carry trade. Despite increases in Japan’s 10-year government bond yield to the highest level in more than a decade, its German equivalent still offers more than 150 basis points of extra yield. 

“The yen continues to see downward pressure from the carry trade,” said Yujiro Goto, head of Japan currency strategy at Nomura Securities Co. “The euro gets extra support from fundamental factors such as sticky service inflation pressure, re-acceleration of wage growth and the economic slowdown bottoming out. The ECB may cut rates in June but its cautious stance overall about the rate cut is another boost to the common currency.”

The ECB shouldn’t rule out lowering borrowing costs at both in its June and July meetings, Governing Council member Francois Villeroy de Galhau said, pushing back against fellow monetary officials who are uncomfortable at the idea of consecutive cuts.

Inflation in the euro-zone is expected to have accelerated to 2.5% on year in May from 2.4% in April, according to median estimate in Bloomberg survey before data due Friday. In the UK, data last week showed consumer prices rose more than expected in April. 

“There may be some more upside for the euro and the pound against the yen,” said Go Ohara, director of the FX trading department at MUFG Bank Ltd. “While some investors liquidate accumulated dollar-long positions, European currencies such as the euro and the pound have been bought, providing extra support.”

Some investors are betting on the chance that European currencies will gain further against the yen, trading options for the euro-yen with a strike price of 175.15 expiring in June, and the pound-yen with a strike price of 202 expiring in July, based on Depository Trust and Clearing Corp. data.

(Adds dollar-yen’s move and BOJ board member Adachi’s comment.)