EUR/JPY: why the forgotten cross is back in focus

In the complex hierarchy of the foreign exchange market, the major pairs tend to monopolize the attention of the financial press. But for the seasoned trader, the truly informative stories are usually found in the crosses. The EUR/JPY pair has quietly emerged as one of the more revealing barometers of the global macroeconomic landscape - often dubbed the "forgotten cross" even though it currently encapsulates nearly every major friction point in the world economy: the normalization of Japanese monetary policy, the persistent inflation struggles of the Eurozone, and the volatile nature of global risk appetite amid ongoing geopolitical instability.

To understand the current macro narrative is to understand the mechanics driving EUR/JPY. While USD/JPY remains the primary vehicle for yen weakness, the EUR/JPY cross offers a more nuanced lens. It filters out the idiosyncratic noise of American fiscal policy and focuses instead on the pure interaction between two distinct economic blocs: a Eurozone struggling with structural energy shocks, and a Japan finally attempting to exit decades of ultra-loose monetary experimentation. This piece breaks down the fundamental, technical, and psychological drivers that make EUR/JPY one of the more relevant trades on the board right now.

The most potent force driving EUR/JPY is the interest rate differential between the European Central Bank (ECB) and the Bank of Japan (BoJ) - and, more specifically, how that gap is narrowing. For years this was a one-way street of yen depreciation, with the BoJ clinging to near-zero rates while the rest of the world hiked. That era is ending, slowly.

In June, the Bank of Japan raised its policy rate by 25 basis points to 1.00%, a level not seen since 1995. The decision was split 7-1 among board members, with one member dissenting in favor of a hold. It wasn't merely a symbolic gesture. It represented a genuine shift in the Japanese economic psyche, one that's been building for two years.

"Considering the recent increase in upside risks to prices, what I envisage as a baseline path is raising the policy interest rate by 0.25 percentage points at intervals of a few months toward the neutral interest rate level of 2%," board member Naoki Tamura said in a speech, arguing the policy rate should gradually move toward a neutral level of around 2%.

That's a notably hawkish framing from inside the BoJ itself. The central bank's own projections point to underlying CPI inflation gradually reaching the 2% target in the second half of the current fiscal year and into the next. Markets are currently pricing the BoJ to hold steady at its next meeting, but a majority of analysts surveyed by Reuters expect one more 25 basis point hike by year-end, taking the policy rate to 1.25%. Some officials, including former BoJ voices, have floated the idea of the bank eventually pushing rates above 2% in this cycle - a scenario that would have sounded far-fetched even eighteen months ago.

Conversely, the ECB finds itself in a far less comfortable position: hiking defensively rather than from strength. In June, the Governing Council raised the three key ECB interest rates by 25 basis points, lifting the deposit facility rate to 2.25%, the main refinancing rate to 2.40%, and the marginal lending rate to 2.65%. It was the ECB's first rate increase since its tightening cycle ended in 2023, and a sharp reversal from the run of cuts delivered over the prior two years.

Unlike the BoJ, which is hiking into a story of domestic recovery, the ECB is playing defense against an energy shock. In the baseline of the new Eurosystem staff projections, headline inflation is expected to average 3.0% this year, easing to 2.3% next year and 2.0% the year after. That's a meaningful upward revision from where the projections stood back in March, and it's driven almost entirely by the trajectory of energy prices. As ECB Governing Council member Isabel Schnabel put it bluntly:

"The risk of de-anchoring inflation expectations is rising," warning the bank could no longer "look through" the shock.

The ECB is effectively squeezed between stagnant growth and stubborn inflation - a combination that forces policymakers to keep rates elevated even as the underlying economy softens beneath them.

Inflationary pressures and GDP disparities

The divergence deepens further when you look at growth. The ECB's baseline sees Eurozone growth averaging just 0.8% this year, a downward revision reflecting the impact of the conflict on commodity markets, real incomes, and consumer confidence. The labor market has held up reasonably well, but the hit to real income from elevated energy prices is hard to miss.

Japan's picture looks slightly brighter, if only by degree. Growth forecasts sit in a similar range to the Eurozone's, but the momentum behind the numbers is pointed the opposite direction. Wage growth has been the story: for the first time in a generation, Japanese workers are seeing meaningful nominal pay increases, something the BoJ views as a genuine prerequisite for hitting its 2% inflation target on a sustainable basis rather than through imported cost-push pressure alone. It's an unusual role reversal - a "wage-price spiral" is normally a central banker's nightmare, but in Japan's case it's read as a welcome sign of life after three decades of stagnation.

So while the headline growth numbers for the two blocs look similar on paper, the direction of travel is not. One economy is normalizing from a position of accumulated strength; the other is hiking to defend a currency and an inflation target under external pressure.

The mechanics of the carry trade

The carry trade remains the invisible hand moving EUR/JPY, and this is where the popular narrative has gotten ahead of itself in recent months. The textbook logic is simple: borrow in yen at a low rate, buy euros (or dollars, or emerging market assets) yielding more, pocket the spread. Historically that spread has been the whole trade.

What's notable about the current environment is that, despite the BoJ's tightening, the carry trade hasn't been dying - it's been thriving. Goldman Sachs strategists described conditions for carry trades as the most compelling in more than two decades, noting that betting on carry bears more relevance in the G10 currency space than at almost any point since 2000. The bank has specifically flagged the yen, alongside the Swiss franc and the euro, as a preferred funding currency for these trades going forward.

That may sound counterintuitive given the BoJ's rate hikes, but it reflects a simple truth: even at 1.00%, Japanese rates remain far below those on offer elsewhere, and Goldman's own house view has the yen weakening further, not strengthening, over the next twelve months, driven in part by the interest rate differential with the US. Japanese authorities haven't been passive about this. Between April and May, Japan spent roughly 71.9 billion dollars intervening in currency markets to try to slow the yen's decline, with limited lasting effect.

None of this means the carry trade is risk-free. Veteran traders know these positions thrive on low volatility, and the BoJ's active tightening cycle has injected exactly the kind of unpredictability that carry strategies dislike. The 2024 episode is still fresh in institutional memory: an unexpected BoJ move that August triggered a rapid carry trade unwind that sent shockwaves through global equities and even crypto markets as leveraged positions were closed in a hurry. Analysts generally point to a handful of early warning signs worth watching - a sudden hawkish shift in BoJ rhetoric, renewed Ministry of Finance intervention, or a sharp, disorderly move in the yen - as the kind of triggers that could flip sentiment quickly.

The takeaway for EUR/JPY specifically: the pair's ongoing strength through the summer isn't a sign that the carry trade is unwinding. If anything, it reflects the opposite - capital continuing to flow out of the yen and into higher-yielding currencies, euro included, even as the rate gap narrows at the margins.

Geopolitics and the safe-haven paradox

The yen's status as a safe-haven currency is one of the more reliable axioms in finance. In the current environment, though, that status is being tested by the specific nature of the conflict weighing on markets. Ongoing instability tied to the Strait of Hormuz - a critical corridor for global oil and gas shipments - has created a genuinely two-sided situation for the yen.

On one hand, geopolitical uncertainty typically triggers a flight to quality, which tends to benefit the yen. On the other, Japan is a resource-poor nation heavily reliant on imported fossil fuels. Rising energy prices are structurally yen-negative because they worsen Japan's trade balance and raise the cost of everything the country has to bring in from abroad. That tension - a crisis making the yen attractive as a haven while simultaneously weakening it on fundamentals - helps explain why the currency hasn't behaved in a textbook "risk-off" fashion despite the conflict grinding on.

Europe faces a parallel dilemma, arguably a sharper one. Roughly a quarter of the world's seaborne crude and petroleum products, along with a significant share of global liquefied natural gas, moves through the Strait of Hormuz, and the Eurozone's industrial base is highly exposed to swings in that supply chain. High energy prices keep the ECB from easing, which is euro-supportive in isolation - but those same high prices squeeze industrial output and household spending, which weighs on the currency from the other direction. In the EUR/JPY cross specifically, these opposing forces often cancel out, producing stretches of tight consolidation even when the geopolitical headlines are anything but calm. That makes the cross a useful real-time gauge of whether markets are prioritizing growth risk or inflation risk at any given moment - and it's worth noting the situation on the ground remains fluid, with cargo flows through the strait fluctuating sharply from week to week as diplomatic efforts continue alongside intermittent flare-ups.

Correlation with equity markets

No discussion of EUR/JPY is complete without its relationship to global equities. The pair has historically shown a positive correlation of roughly 0.6 with the S&P 500 and other major indices, cementing its reputation as a "risk-on" currency pair. When global investors feel optimistic, they tend to sell the low-yielding yen to fund purchases of higher-returning assets elsewhere, which pushes EUR/JPY higher.

When a shock hits - a sudden air pocket in AI-related tech valuations, say, or an escalation in the Middle East - that correlation tends to tighten fast. In those moments EUR/JPY becomes something closer to a high-beta proxy for global risk sentiment. Some traders use the cross defensively: if you're long European equities, a short EUR/JPY position can act as a partial hedge against a broader market drawdown, since both tend to move together in a sell-off.

Technical analysis and current price action

The EUR/JPY chart tells a story of a multi-year uptrend that has largely held together despite plenty of reasons it could have broken down. The pair climbed out of the mid-150s in 2024 and has spent the better part of two years grinding higher, with shallow pullbacks and consistent buying interest around the moving averages.

As of writing, EUR/JPY is trading in the mid-180s, close to its highs for the year, having posted four consecutive bullish weekly candles - its first such streak in over a year. The 185 handle has become the market's focal point. A failure to hold below resistance could allow the pair to extend toward the next resistance cluster near 186, while support sits in a cluster around the 184.90 to 185.20 zone, with a deeper floor near 183.70 should the current consolidation pattern break to the downside.

The 200-day moving average - the market's usual dividing line between a structural uptrend and a structural downtrend - currently sits below spot price, reinforcing the broader bullish backdrop. RSI readings in the mid-50s suggest the pair is neither overbought nor oversold, which is consistent with a market that's grinding higher rather than blowing off steam. Whether EUR/JPY breaks decisively above resistance or rolls over into a deeper consolidation likely hinges less on the charts themselves and more on the next moves from Frankfurt and Tokyo - and, more unpredictably, on Japan's Ministry of Finance, which has shown a willingness to intervene when it judges the pace of yen weakness to be disorderly.

Forecast scenarios

Institutional forecasters remain split on where the pair lands by year-end, with estimates spread across a wide range. Broadly, three scenarios capture the plausible paths from here:

• Bullish continuation. The BoJ moves cautiously, hiking once more to 1.25% at most, while the ECB is pushed into at least one further hike by persistent energy-driven inflation. Global risk sentiment stays constructive, supported by continued AI-linked capital spending. This path points toward a retest and possible break of the recent highs.
• Range-bound consolidation. Policy divergence reaches something like a stalemate: BoJ hikes are offset by Eurozone stagnation, and the pair chops within a wide band as the market waits for a clearer catalyst. This is the "wait and see" environment that tends to frustrate short-term traders the most.
• Bearish pullback or carry unwind. The tail-risk scenario. If the BoJ accelerates faster than expected - a jump to 1.50% or beyond - while the Eurozone tips into a more formal downturn, a rapid carry unwind becomes plausible. This would likely coincide with a break of the 200-day moving average and a retreat toward the low 170s.

Academic and historical context

Interest Rate Parity and Purchasing Power Parity remain the textbook foundations of exchange rate theory, but in practice they're being stress-tested by conditions that don't fit neatly into either framework. The sensitivity of the yen to inflation differentials is running at some of its highest levels in decades, and empirical work on exchange rate forecasting consistently finds that the link between rate differentials and spot prices is strongest precisely during periods of policy transition - which is exactly the phase both the BoJ and ECB find themselves in.

Historically, EUR/JPY has also functioned as something of an early warning signal for liquidity stress. Because the yen remains the world's dominant funding currency for cross-border carry positions, a sudden bout of yen strength - and the corresponding drop in EUR/JPY - has often preceded broader tightening in global liquidity conditions. Watching this pair, in other words, isn't just about trading one currency cross. It's a reasonable proxy for the plumbing of the global financial system more broadly.

Practical guidance for investors and businesses

For companies operating across the Eurasia corridor, EUR/JPY volatility represents a genuine balance sheet risk, not an abstract trading concern. Hedging approaches that worked well when volatility was low - simple forward contracts, for instance - have gotten notably more expensive as implied volatility has risen. A more dynamic approach, combining options to cap downside exposure while still allowing some participation in favorable currency moves, has become the more common playbook this year.

For investors, the operative word is discipline. The carry trade is not a "set it and forget it" strategy in this environment - it requires active monitoring of BoJ communications, Eurozone inflation prints, and developments around the Strait of Hormuz that could shift the energy-price calculus quickly. In a year defined by policy divergence, the EUR/JPY cross captures more of that story in a single chart than almost any other instrument in the currency market.

Traders exploring related crosses may also find it worth reading up on how the BoJ's normalization path is separately reshaping USD/JPY dynamics, since the two pairs are increasingly telling overlapping but distinct parts of the same story.