Euro sticks to modest recovery gains vs Yen; remains close to YTD low ahead of ECB

• EUR/JPY gains some positive traction on Thursday, though the upside potential seems limited.
• An aggressive repricing of a more hawkish BoJ continues to underpin the JPY, capping the cross.
• Traders now look forward to the crucial ECB rate decision before placing fresh directional bets.

The EUR/JPY cross struggles to capitalize on its modest intraday gains and trades around the 178.75 region during the first half of the European session on Thursday. Meanwhile, spot prices remain within striking distance of the year-to-date low, touched on Tuesday, as traders keenly await the European Central Bank (ECB) rate decision.

A 25-basis-point (bps) ECB rate hike for the second time this year is all but certain, suggesting that the key focus will be on the central bank's outlook for its longer-term policy path amid persistent inflationary pressures. In fact, the official flash estimate showed that Eurozone annual inflation rose to 3.3% in August, up from 2.9% in the previous month. Furthermore, investors remain worried about inflation risks stemming from higher energy prices, bolstered by escalating tensions in the Middle East.

Hence, ECB President Christine Lagarde's comments during the post-meeting press conference will play a key role in influencing the Euro and provide some meaningful impetus to the EUR/JPY cross. Heading into the key central bank event risk, the bearish sentiment surrounding the US Dollar (USD) is seen lending some support to the Euro. The Japanese Yen (JPY), on the other hand, pauses for a breather following a hawkish Bank of Japan (BoJ) inspired rally and lends additional support to the EUR/JPY cross.

Traders have fully priced in a 25 bps BoJ rate hike at its upcoming meeting on September 17–18 and are assigning a high chance of a follow-up move in December. The bets were lifted after BoJ's prominent hawkish members – Hajime Takata and Naoki Tamura – recently pushed for faster and more nimble rate hikes to counter rising inflation. Moreover, BoJ's Kazuyuki Masu said earlier today that underlying inflation is approaching 2% and the policy rate is still below our estimated range for a neutral rate.

Adding to this, a combination of revised economic growth and strong wage gains bolstered the central bank’s normalization path. This might hold back traders from placing aggressive bearish bets around the JPY and keep a lid on the EUR/JPY cross, suggesting that any further up move could get sold into. Hence, it will be prudent to wait for strong follow-through buying before confirming that spot prices have formed a near-term bottom around the 177.85 region and positioning for any meaningful recovery.