British Pound strengthens vs weak Yen; upside seems capped amid intervention risks

• GBP/JPY gains positive traction for the second straight day, though the upside seems capped.
• The BoJ’s hawkish rate hike on Friday continues to undermine the JPY and supports the cross.
• The divergent BoJ-BoE stance and JPY intervention risks should cap upside for spot prices.

The GBP/JPY cross attracts fresh buyers at the start of the new week, stalling Friday's retracement slide from the 211.25-211.30 area, or a nearly two-week high. Spot prices stick to modest intraday gains through the first half of the European session and currently trade just below mid-210.00s, up 0.15% for the day.

The Japanese Yen (JPY) continues with its relative underperformance on the back of the Bank of Japan's (BoJ) surprisingly dovish decision last Friday and is seen as a key factor acting as a tailwind for the GBP/JPY cross. The widely expected BoJ rate hike to a 31-year high was accompanied by two dissenters, who argued for patience in pushing up borrowing costs. This, in turn, pointed to a broadly divided board and tempered expectations for a faster pace of future tightening.

Nevertheless, the BoJ is widely expected to proceed with a measured normalization path. In contrast, the Bank of England (BoE) maintains a more cautious holding or gradual easing bias amid stagflation fears, fueled by energy-driven inflation concerns and weakening growth. The resultant narrowing of the rate differential between the two economies might lead to the British Pound's (GBP) relative underperformance against the JPY and cap gains for the GBP/JPY cross.

Pound seen at risk as market pricing outpaces BoE tightening needs

Strategists at Brown Brothers Harriman highlight that the UK rates market remains aggressively priced, with the swaps curve still implying “about 100bps of BOE rate hikes in the next twelve months to 4.75%.” However, they argue that “the BOE may not need to tighten as much as markets expect,” noting that “the UK economy is already operating below capacity,” while the current “Bank Rate at 3.75% is near the top of the BOE’s estimated 2% to 4% neutral range,” and that “fiscal policy will likely turn more restrictive.” In BBH’s view, the “bottom line: GBP remains vulnerable to a dovish BOE repricing.”

Meanwhile, the BoJ conducted a rate check on Friday, reviving expectations for another intervention in the currency market. This might further hold back traders from placing aggressive bearish bets on the JPY and contribute to keeping a lid on any further appreciation for the GBP/JPY cross. Hence, it will be prudent to wait for strong follow-through buying before positioning for an extension of the recent recovery from the year-to-date low, touched earlier this month.