Will differences between UK and Japan be reflected in GBP and JPY?
This week has been one of contrasts between the UK and Japan with the former seeing a robust economy while the latter reporting a brutal contraction in Q2. GBP/JPY has been in retreat recently, but that could be reversed.
Japan's economy contracted at annualised rate of 6.8% during Q2, the biggest fall since the Tsunami of March 2011. Among the main causes of the fall was the rise in the sales tax on April 1, which exaggerated the contraction as many consumers rushed to make purchases before it was introduced.
The question will now be whether this is just a distortion that will correct itself over the course of the year or whether the economy has been permanently stunted by the tax increase. In the meantime, Japan is still pursuing its quantitative easing programme.
The question over the coming quarters will focus on whether Japan may need even more stimulus from the government and the central bank. Indeed, if Japan is falling back towards stagnation then that would definitely be a negative for JPY.
Another factor to watch are the asset allocation plans of the country's $1.2 trillion Government Pension Investment Fund. If it decides to park more assets abroad that could also be drag on JPY.
GBP/JPY sell-off looking over-done
The UK economy on the other hand has seen something of a Lazarus moment this year with growth around 3% and this is expected to continue. Also, the housing market is firm, jobs are being created and consumer and business confidence appears to be robust.
However, the UK's recovery is not without its problems. Wage growth still seems to lag inflation and the current account deficit remains large. If the recent economic set-backs in Germany and France are part of a wider trend then the current account deficit will very likely widen. That would be bearish of GBP.
Also, the Bank of England has been dovish recently and market expectations of a rate rise have been scaled back, which has hit GBP hard. Also, the BoE seems to be focussing on wage inflation as a reason not to raise interest rates and believes that wages will not see big rises this year.
Nonetheless, a rate rise is likely to come a lot sooner in the UK than Japan plus the Bank of England has long stopped its quantitative easing programme. Thus the sell-off on GBP against the majors including JPY is looking over-done.
JPY looks set for further weakness with one very important caveat. And that is should there be a big pick up in fear across the markets due to geopolitical factors or a global growth slowdown then JPY would trounce GBP as the former is seen as a safe haven currency and the latter is a risk one.
By Justin Pugsley, Markets Analyst MahiFX