GBP/JPY higher as sterling outperforms on positive data

• GBP/JPY makes gains after a slew of positive UK data, including strong PMIs.
• Support is limited by the strength of the yen, following comments from BoJ Governor Ueda.
• Japan’s inflation data raises concerns that inflation may fall, making the BoJ’s policy normalization more difficult.

GBP/JPY is trading hands in the 191.60s on Friday, marginally up on the day – its third consecutive day of gains so far. The pair is benefiting from a stronger pound sterling (GBP), which rose after survey data indicated an increase in business activity in August.

According to a survey that gauges purchasing managers across major sectors – the preliminary UK S&P Global/CIPS Composite Purchasing Managers’ Index (PMI) – responses were positive, rising to 53.4 in August from 52.8 in July and beating economists’ expectations of 52.9, data presented Thursday.

The S&P Global/CIPS Manufacturing PMI rose to 52.5 from 52.1, beating expectations that it would remain unchanged. UK services PMI rose to 53.3 from 52.5 when an increase to 52.8 had been expected.

The data gave GBP a boost across all its peers and compared favorably with the more mixed picture in other major economies.

It was based on recent positive UK retail sales data, which showed a return to sales growth in July after a dip in June.

Not all UK data has been positive of late: government borrowing was higher than expected in July, although this impact on financial markets partly depends on the government’s response over time. Consumer confidence missed estimates in August and factory orders were mixed.

Broad market expectations continue to price in a 0.25% cut by the Bank of England (BoE) before the end of 2024, with some analysts predicting a total of 0.50% of cuts (in two tranches) before the end of the year . Expectations of lower interest rates are negative for a currency as they reduce foreign capital inflows, so if markets maintain their current narrative, GBP is likely to remain capped.

Meanwhile, the Japanese yen (JPY) gained some support on Friday after Bank of Japan (BoJ) Governor Kazuo Ueda testified in parliament. Ueda reiterated that the BoJ “will raise interest rates further if the economy and prices move in line with our projections.” His suggestion that interest rates could rise, strengthening the yen.

According to Brown Brothers Harriman, swap markets “implicate a 36% probability of a 25bps BoJ rate hike by December” following Ueda’s speech.

However, markets are skeptical about the extent to which Japanese inflation will continue to rise, leaving the BoJ unable to raise interest rates.

Recent data for July, for example, showed that Japan’s consumer price index (CPI), excluding fresh food and energy, fell from 2.2% year-on-year in June to 1.9% in July, bringing below the BoJ’s 2.0% target for the first time since 2022. One reason for the decline was a sharp decline in processed food inflation, while “other industrial products” inflation held just above 2.0%.

Headline CPI held steady at 2.8%, the same as in June, and CPI excluding fresh food rose to 2.7% from 2.6%, in line with economists’ estimates. However, these two figures remained higher due to the Japanese government’s phasing out of energy subsidies rather than increased demand – and the subsidies are due to be restored in September.

“Headline inflation held steady at 2.8% in July, while inflation excluding fresh food rose from 2.6% to 2.7%, in line with analysts’ consensus. However, the main reason for this persistent strength was a further sharp rise in energy inflation, from 7.7% to 12.0%, which boosted headline inflation by 0.3%-points. The rise in energy inflation largely reflects the temporary removal of government energy subsidies, but those subsidies will be reinstated from September, so energy inflation will fall again soon,” says Marcel Thieliant, head of Asia-Pacific at Capital Economics.

In addition, service inflation remains weak in Japan despite government claims that wages are rising. CPI data showed services inflation eased to 1.4 percent in July from 1.7 percent previously.

However, despite fresh food and energy CPI falling below the BoJ’s target, the BoJ itself forecast such a drop, and Governor Ueda cautioned his testimony that the bank would only raise interest rates if the data were in line with projections its. .

“Otherwise, July’s inflation numbers clearly undercut the case for further tightening. That said, the Bank has already factored in a further slowdown in core inflation in its forecasts. The median forecast by members of the Board of Governors of the Bank of Japan for inflation, excluding fresh food and energy, for the fiscal year ending March 2025 is 1.9%. Given that this measure of inflation averaged 2.2% in the first four months of the fiscal year, it will need to fall below 2% soon to meet this forecast,” adds Thieliant.