EUR/JPY pushes to multi-week highs above 131.00 as Eurozone/Japan rate differentials widen

• EUR/JPY has rallied above 131.00 on Tuesday as Eurozone/Japan rate differentials widen amid Omicron-optimism.
• Should risk-on market conditions continue, a continued push towards Q4 2021 highs in the mid-133.00s is likely.

Amid broad yen weakness following a recent widening in G10/Japan rate differentials, EUR/JPY has rallied on Tuesday to its highest levels since mid-November above the 131.00 mark. At current levels close to 131.20, the pair is up about 0.7% on the session, its best such on-the-day gain since early December. Yields in Europe have rallied this week in tandem with yields in the US as market participants broadly price in a stronger outlook for the global economy in 2022 and beyond as Omicron-related fears subside. Omicron seems to be decisively “weaker” than delta, which it seems likely to replace as the dominant Covid-19 strain, and is three times less likely to result in hospitalisation. Moreover, these hospitalisations seem significantly less severe, something the UK vaccine minister recently said.

The 10-year German yield is above -0.15% and eyeing a test of post-pandemic highs above -0.10%, meaning it is up about 4bps on the week and over 25bps since the December lows. Japan 10-year yields, meanwhile, are only up 2bps on the week and about 6bps from the December lows, given that (as ever) they remain pinned close to 0.0% by the BoJ’s ongoing Yield Curve Control (YCC) programme. The recent approximate 20bps upwards shift in German/Japan rate differentials since mid-December as a result of the market’s surge in risk appetite in recent weeks has been a key driver of EUR/JPY’s rally from last month’s lows in the 127.50 area.

At current levels above 131.00, the pair is up more than 3.0% versus these recent lows. If optimism about the global economic outlook this year continues to grow, EUR/JPY may soon look to challenge its Q4 2021 high in the mid-133.00s, or perhaps even the 2021 highs just above 134.00. Though the ECB remains a long way from hiking interest rates, its rate of monthly QE buying is set to decline substantially in 2022 versus no change expected to the BoJ’s flagship YCC QE programme. QE policy divergence could well offer EUR/JPY longer-term support.