EUR/JPY advances as Japanese Yen falters on fiscal, political instability

• EUR/JPY trades higher, supported by Japanese Yen weakness linked to fiscal and political concerns in Japan.
• Eurozone activity indicators disappoint, with the services sector slowing more than expected in January.
• Cooling inflation and a cautious European Central Bank limit the Euro’s upside potential.

EUR/JPY trades around 185.10 on Wednesday at the time of writing, up 0.55% on the day and reclaiming the 185 level. The cross is mainly supported by the persistent underperformance of the Japanese Yen (JPY), as investors remain concerned about Japan’s fiscal outlook and political uncertainty ahead of the snap lower house election.

The Japanese Yen remains under pressure ahead of this weekend’s election. Prime Minister Sanae Takaichi’s ruling Liberal Democratic Party is expected to strengthen its majority, backed by a platform focused on higher public spending, tax cuts and a new security strategy. This expansionary fiscal stance has revived concerns over the sustainability of Japan’s public debt.

The Prime Minister’s remarks, initially interpreted as favoring a weaker JPY to support exports, reinforced the perception of official tolerance for a softer currency, even though she later clarified her comments. Fears of coordinated Japan-US intervention and the Bank of Japan’s (BoJ) slightly more hawkish tilt are, however, limiting a sharper depreciation of the Japanese currency.

In the Eurozone, the latest macroeconomic data send mixed signals. The Eurozone HCOB Services Purchasing Managers Index (PMI) came in at 51.6 in January, a four-month low, below market expectations and down sharply from December. In Germany, the downward revision of the HCOB Services PMI to 52.4 confirms that activity in the region’s largest economy remains sluggish. These figures highlight the fragility of the economic recovery and cap the Euro’s (EUR) fundamental appeal.

On the inflation front, price pressures continue to ease. The Eurozone Harmonized Index of Consumer Prices (HICP) rose by 1.7% YoY in January, in line with expectations but down from 1.9% in December, while core inflation remained steady at 2.3%. This cooling inflation backdrop supports the case for a cautious monetary policy stance.

According to Deutsche Bank, the European Central Bank (ECB) is likely to keep interest rates unchanged through 2026, with the next move potentially being a hike in 2027. "The path of monetary policy in 2026 will depend on who wins the contest between external conditions and internal conditions. Our baseline assumes that domestic resilience will dominate and that leads to hikes in 2027", noted the bank’s research team.

In this environment, EUR/JPY dynamics are driven more by structural Japanese Yen weakness than by Euro strength. As long as political and fiscal uncertainties weigh on the Japanese currency, the cross may remain supported, despite still-fragile fundamentals in the Eurozone.