Pound to yen (GBP/JPY) analysis as the BoJ and BoE diverge

The pound to yen (GBP/JPY) exchange rate retreated to its lowest point since May 16th amid the rising hopes of Bank of Japan (BoJ) and Bank of England (BoE) divergence. It dropped to a low of 194.75 on Wednesday, much lower than the year-to-date high of 208.08. 

Bank of Japan rate hike

The biggest monetary policy-related event was the latest Bank of Japan interest rate decision. In it, the bank continued its tightening phase as it made its biggest interest rate hike in over a decade.

It brought interest rates from 0% to 0.25% and announced measures to scale down its big quantitative easing plan by halving its monthly bond purchases. The rate hike happened a few months after the BoJ ended its negative interest rates. 

The rate hike happened at a precarious time for the Japanese economy. Its currency has tumbled to a multi-decade low while there are signs that the economic growth has slowed. 

Inflation is still at an elevated level in Japan’s standards while the ongoing yen rebound is partly because of government’s interventions. The most recent data showed that the core consumer price index (CPI) rose to 2.6% in July.  In a note, analysts at UBS said:

These rate hikes mean that the Japanese government will have to dig deeper to fund its operations because of its substantial debt load. Japan is the most indebted country in the G7 with a debt to GDP ratio of almost 270%. As such, any rate hike means that the government will need to pay more to service its obligations.

It is unclear whether the BoJ will hike rates once again. Analysts believe that it will not do so since the economy is slowing, with industrial output falling. 

Bank of England rate decision ahead

The next important GBP/JPY news will come out on Thursday when the Bank of England (BoE) delivers its interest rate decision.

Unlike the BoJ, the BoE is expected to cut interest rates by 0.25% to 5.0%. That will happen for two main reasons. First, to a large extent, the bank has achieved its inflation goals as the headline Consumer Price Index (CPI) has remained at 2.0% for two consecutive months. 

However, the core CPI, which excludes the volatile food and energy prices, has remained above 3% this year. 

Second, there are signs that the British economy is slowing. While the recent manufacturing and services PMIs have been strong, the current administration has identified a £22 billion gap in its budget. As a result, Rachel Reeves, the exchequer has hinted that the government will need to raise taxes in the coming weeks. In a note, an Allianz analyst said:

Still, Huw Pill, the Bank of England’s Chief Economist, has warned that the country is still going through substantial inflation. He pointed to core CPI, which has remained above 3% in the past few months. As a result, he has advocated for patience before the bank starts cutting rates. 

In a comprehensive report, analysts at ING identified four scenarios. In the first one, they expect the bank to vote for a rate cut, with 7 members voting in favor. Its base case is where the bank cuts by 25 basis points with 6 members supporting. The other two scenarios are no rate cut with 5 and 7 members voting in favor. 

The BoE decision could also be impacted by what the Federal Reserve does on Wednesday. Analysts expect that the Fed will leave interest rates unchanged between 5.25% and 5.50% and point to a September cut. If this is the outcome, the BoE could decide to cut or wait for the Fed. 

GBP/JPY technical analysis

GBP/JPY chart by TradingView

The daily chart shows that the pound to rand exchange rate has slipped hard in the past few weeks. It has fallen from a high of 208 in July to 196 today. The pair is also hovering at the 23.6% Fibonacci Retracement point and moved below the 50-day moving average. 

Meanwhile, oscillators like the Relative Strength Index (RSI) and the Stochastic Oscillator have all pointed downwards. Therefore, the emerging BoJ and BoE divergence mean that the pair could drop some more in the next few days as sellers target the key support at 190. It will then resume the uptrend as investors embrace the new normal.