Australian Dollar remains depressed; downside seems limited as fiscal concerns weigh on Yen

• AUD/JPY drifts lower on Thursday, stalling its recent goodish recovery from a multi-month trough.
• Bets that the RBA will leave rates unchanged prompt AUD profit-taking and weigh on the cross.
• Japan’s fiscal concerns undermine the JPY and limit losses amid the wide BoJ-RBA rate gap.

The AUD/JPY cross attracts some sellers on Thursday, snapping a two-day winning streak and stalling this week's solid bounce move from its lowest level since late March. Spot prices slide back to the 111.00 mark during the first half of the European session amid a broadly weaker Australian Dollar (AUD), though the downside potential seems limited.

The Australian Dollar (AUD) drifts lower as a modest US Dollar (USD) strength prompts some profit-taking following the recent rally to a seven-week high. Apart from this, expectations that the Reserve Bank of Australia (RBA) is done raising interest rates and maintain the status quo next week contribute to the AUD's underperformance and exert some downward pressure on the AUD/JPY cross.

Analysts at Standard Chartered judge that “our base case remains that the RBA is done with rate hikes in the foreseeable future,” reflecting their view that the current policy stance is likely sufficiently restrictive for now. However, they caution that the balance of risks is not entirely one-sided, noting that “the risk to our view is skewed towards another RBA rate hike in Q4, if the central bank remains unconvinced that demand is slowing sufficiently to contain underlying price pressures.”

The intraday slide seems unaffected by the upbeat Australian Trade Balance data, which showed a surplus of A$1,929 million in June, compared to a deficit of A$1,100 million. However, a softer Japanese Yen (JPY) could limit deeper losses for the AUD/JPY cross. The brutal market reaction to a joint US-Japan intervention last week fades amid concerns about Japan's worsening fiscal condition.

Japan's ruling Liberal Democratic Party (LDP) backed a proposal to cut the food consumption tax from 8% to 1% for two years starting in April 2027. Moreover, the government proposed roughly ¥600 billion a year in cash transfers targeted at low- and middle-income households as part of a relief package. Nevertheless, the lack of a clear funding mechanism remains a key concern, undermining the JPY.

Furthermore, borrowing costs in Japan remain exceptionally low relative to other major economies, including Australia, despite the Bank of Japan's (BoJ) rate hike in June to 1%, or the highest since 1995. This keeps the so-called JPY carry trade action, which, in turn, makes it prudent to wait for strong follow-through selling before confirming that the AUD/JPY pair's recent recovery has run out of steam.