EUR/JPY falls as Bank of Japan faces pressure to raise rates

• EUR/JPY slips on upbeat Japanese data and elevated inflation.
• Germany's Retail Sales and preliminary inflation figures provide a mixed picture for the Euro, providing an additional headwind for the ECB.
• A hawkish Bank of Japan and a data-dependent European Central Bank drive EUR/JPY price action.

The Euro (EUR) is coming under renewed pressure against the Japanese Yen (JPY) as investors weigh persistent inflation in Japan against soft consumer and inflation data from the Eurozone. With the European Central Bank (ECB) already in easing mode and the Bank of Japan (BoJ) edging toward further policy tightening, the broader backdrop is shifting in favour of the Yen.

At the time of writing, EUR/JPY is trading below 164.00, with the next layer of support resting at 163.00.

Resilient Retail Sales and rising inflation in Japan support the Yen 

Japan's latest data has reignited expectations for further tightening from the BoJ. Tokyo's Core Consumer Price Index (CPI), a leading inflation indicator, rose 3.4% YoY in May, compared to 3.5% the previous month, while the CPI excluding fresh food rose 3.6%, its highest level in two years. The data showed that the increase was driven by sharply higher food prices, including a 93% surge in rice costs.

Retail sales also exceeded expectations, rising 3.3% YoY in April, indicating that consumer demand remains resilient despite rising prices. Industrial production contracted by 0.9% MoM in April, a smaller decline than the 1.4% contraction expected, adding to evidence that Japan's economy is holding up better than anticipated.

Together, these figures have strengthened the case for another rate hike from the Bank of Japan. Having already exited negative interest rates earlier this year, the central bank is under increasing pressure to normalise policy further, especially if inflation continues to surprise on the upside.

German Retail Sales and inflation provide mixed signals

By contrast, recent data from Germany, the Eurozone's largest economy, painted a more fragile picture. Retail sales in April declined by 1.1% MoM, missing expectations for a 0.2% increase. Although the YoY figure showed some strength at 2.3%, the sharp monthly drop raised concerns about the health of domestic demand.

Inflation data was mostly in line, though the Harmonised Index of Consumer Prices (HICP)--the European Union's standardised measure- came in slightly above expectations, rising 0.2% MoM and 2.1% YoY. Still, the ECB  remains data-dependent, balancing the economic outlook with inflation expectations. 

EUR/JPY reviews policy divergence expectations between the ECB and the BoJ

The policy divergence between the European Central Bank and the Bank of Japan is becoming increasingly clear. While the ECB looks set to continue reducing rates cautiously amid mixed economic signals, the BoJ is under growing pressure to tighten further as inflation gains traction.

This divergence supports a bearish bias for the EUR/JPY pair. As long as Japanese inflation remains firm and economic activity continues to hold up, the Yen is likely to remain supported. Meanwhile, the Euro could come under further pressure if Eurozone growth data continues to underwhelm or if the ECB signals the potential for additional rate cuts.