The Pound and Yen Crisis: A Strategic Case for Dollar and Euro Longs in a Fragmenting Global Currency Market

The global currency market is increasingly fragmented, with the British pound (GBP) and Japanese yen (JPY) emerging as focal points of instability. As fiscal and political uncertainties deepen in the UK and Japan, investors are recalibrating their strategies to hedge against volatility. This analysis argues that positioning in the U.S. dollar (USD) and euro (EUR) offers a compelling strategic advantage, given the deteriorating fundamentals of GBP and JPY and the divergent monetary trajectories of major central banks.

The UK’s Fiscal Quagmire and GBP Weakness

The UK’s 2025 fiscal policy remains a source of significant economic and political instability, undermining confidence in the pound. Prime Minister Keir Starmer’s contemplation of a cabinet reshuffle has heightened market sensitivity to policy shifts, particularly as the UK grapples with a current account deficit and persistent inflation [4]. According to a report by the Resolution Foundation, the Chancellor’s “zero-based” spending review—a first since 2008—reflects constrained fiscal headroom amid rising tax burdens and an uncertain trading environment [1]. While the Bank of England (BoE) has avoided aggressive monetary tightening, the lack of decisive action has left GBP vulnerable to depreciation. As of September 2025, GBP/USD has risen above 1.35, with analysts forecasting further weakness as inflation peaks at 3.6% in Autumn 2025 [2].

The Autumn Budget, expected to include tax hikes to adhere to fiscal rules, may provide short-term stability but risks exacerbating growth challenges. KPMG’s UK Economic Outlook notes that GDP growth of 1.2% in 2025 is contingent on strong public spending and household savings, which are themselves under pressure from inflationary pressures [2]. The BoE’s Monetary Policy Committee (MPC) faces a delicate balancing act: further rate cuts could fuel inflation, while tightening could stoke recessionary risks. This uncertainty positions the GBP as a high-risk asset, making the USD an attractive hedge.

Japan’s Political and Monetary Crossroads

Japan’s currency market is equally volatile, driven by leadership uncertainty and divergent monetary policy. Prime Minister Shigeru Ishiba’s resignation in early September 2025 triggered a sharp 0.7% drop in the yen against the dollar, as analysts speculated on expansionary fiscal policies under potential successors like Sanae Takaichi [3]. Bloomberg reports that Takaichi’s preference for aggressive stimulus measures—such as cash handouts or consumption tax cuts—could delay the Bank of Japan’s (BOJ) normalization of monetary policy, further weakening the yen [1].

Despite recent BOJ rate hikes pushing JPY/USD from 157 to 148, the yen’s strength is constrained by Japan’s 260% public debt-to-GDP ratio and slower growth compared to the U.S. [5]. Deloitte’s July 2025 economic outlook highlights that Japan’s real GDP contracted slightly in early 2025 before a modest recovery is anticipated, with growth projected at 0.5%–0.7% for the year [3]. Meanwhile, Japanese government bond (JGB) markets have become increasingly volatile, reflecting concerns over fiscal discipline and inflation, which remains above the BOJ’s 2% target [2].

The yen’s vulnerability is compounded by global trade tensions and the U.S.-Japan trade deal’s limited impact. While reduced tariffs have provided temporary relief, the yen’s 3.63% depreciation over the past 12 months underscores its susceptibility to divergent monetary policies between the BOJ and the Federal Reserve [5].

Strategic Case for Dollar and Euro Longs

The USD and EUR emerge as strategic longs in this fragmented landscape. The U.S. dollar’s strength is underpinned by the Federal Reserve’s anticipated rate cuts, which, while easing monetary tightening, remain more disciplined than the BoE’s or BOJ’s approaches. The UK’s fiscal challenges and Japan’s political instability amplify the dollar’s safe-haven appeal, particularly as GBP and JPY face downward pressure.

The euro, meanwhile, benefits from the European Central Bank’s (ECB) more stable policy framework. Unlike the UK and Japan, the Eurozone has avoided extreme fiscal expansion, with inflationary pressures easing and growth stabilizing. EUR’s relative resilience against GBP and JPY—bolstered by the ECB’s cautious normalization path—makes it a logical counterbalance to the pound and yen’s fragility.

Investors should also consider the interplay between geopolitical risks and currency positioning. As global trade tensions persist and central banks diverge in policy, the USD and EUR are likely to outperform in a scenario where GBP and JPY underperform.

Conclusion

The pound and yen crises underscore the fragility of currencies in economies grappling with fiscal and political instability. For investors, the strategic imperative is clear: dollar and euro longs offer a robust hedge against the uncertainties plaguing the UK and Japan. As the BoE and BOJ navigate their respective challenges, the USD and EUR are poised to benefit from their stronger policy frameworks and global demand for stability.

Source:
[1] Budgets and fiscal events [https://www.resolutionfoundation.org/our-work/economy-public-finances/budgets-fiscal-events/]
[2] UK Economic outlook [https://kpmg.com/uk/en/insights/economics/uk-economic-outlook.html]
[3] Japan economic outlook, July 2025 [https://www.deloitte.com/us/en/insights/economy/asia-pacific/japan-economic-outlook.html]
[4] Pound to Dollar Forecast: Scope for GBP to Retest Resistance Near 1.36 [https://www.currencynews.co.uk/forecast/20250907-43976_pound-to-dollar-forecast-scope-for-gbp-to-retest-resistance-near-136.html]
[5] How Strong Will the Japanese Yen (JPY) Be In 2026? [https://www.disruptionbanking.com/2025/09/04/how-strong-will-the-japanese-yen-jpy-be-in-2026/]