The TANKAN survey of large manufactures printed in line with expectations, but after a series of disappointing economic results from Japan last week, tonight’s news was viewed with relief as it boosted hope that BOJ may raise rates as early as August. Although the projections for capital expenditures were actually slightly lower than forecast, the overall TANKAN number indicated that Japanese business sentiment for Q2 remained strong and should prove supportive for Japanese growth going forward, After a knee jerk rally to 123.25, USDJPY dropped throughout the night reaching a low of 122.60 by early European trade.

The pair continues to find massive resistance at 125.00 as many different market participants are coming to the consensus that the yen has devalued to far too fast. In Japan, even some businessmen are concluding that the competitive advantages of a lower currency are negated by the rapidly rising input costs to industry. With oil above $70/bbl, the decline in yen has forced input prices to skyrocket in a country that imports 98% of it energy needs. The weak currency has also weighed heavily on consumption, with fewer and fewer Japanese purchasing vehicles. Japan June newly-registered vehicle sales dropped -11.2% on a year over year basis with annual totals running at 20% less than a decade ago as diminishing purchasing power stifles demand. In short public opinion in Japan may be coming to the conclusion that the benefits of a lower yen no longer exceed the costs, providing the BOJ with more political leeway to raise rates despite the still low inflation gauges.

The euro meanwhile has crept to within 20 points of the 1.3600 figure as tonight’s EZ PMI data printed slightly better than the flash forecast last week. The final PMI recorded a reading of 55.6 vs. 55.4 initially expected, comfortably above the 50 boom/bust line indicating that the EZ expansion continues at a healthy pace.

Key event risk for the Euro this week will come on Thursday when ECB holds its monthly press conference. No one expects any rate hikes to be announced in July, but traders will be focused on the statement of ECB president Jean-Claude Trichet about any possible policy changes in August or September. Typically the ECB likes to forewarn the markets of any upcoming rate hikes and “vigilance” has become the codeword for upcoming tightening. It’s difficult to say if ECB will choose to raise rates in August during the peak of European vacation season. For now it is not scheduled to meet. Most probably the tradition bound institution will decide to wait until September to enact a change in policy and that may cause a slight sell off in the unit after the press conference from speculative accounts looking for a faster pace of tightening from Mr. Trichet and company.

Boris Schlossberg is a Senior Currency Strategist at FXCM.