Besides the Italian budget story and Brexit, preliminary inflation readings out of the Eurozone are highly likely to spark volatility in the euro this week, affecting opinion about whether a rate hike by the European Central Bank is appropriate next year. The report is due on Friday at 1000 GMT, with investors estimating some weakness in the headline Consumer Price Index (CPI). On the other hand, the core measure is expected to gain momentum, though within a familiar field.
Consumer prices across the 19-member eurozone bloc surged by 2.2% year-on-year in October in line with expectations thanks to elevated oil prices, reaching the highest rate in almost six years. During November, oil has experienced a sharp sell-off and analysts are now seeing inflation returning to 2.0%. In the absence of food and energy, however, the core equivalent is projected to edge back up to 1.3% y/y from 1.2% registered in the preceding month, an unbreakable level since 2013.
While this messages that inflation has been resilient despite fragilities in the euro economy, the number is still far below the ECB’s 2.0% price target, hinting that the goal achievement might be a long process and hence plans for a rate hike as soon as next year might come under second thought in subsequent months. Note that initial inflation expectations reported through the PMI survey and first estimates on consumer confidence measured by the European Commission appeared at the lowest in more than a year in November. It is also worth mentioning that the Eurozone’s GDP growth in Q3 was the lowest since the end of 2016. Declining government bond yields in Germany as well as in other EU economies are another evidence that investors do not see stronger inflationary pressures on the horizon yet.
The quantitative easing program, which stimulates the economy by buying government bonds, is on track to end in December, the ECB chief Mario Draghi confirmed on Monday, highlighting that the decision remains subject to upcoming data. Having said that, he also reiterated that the Bank will continue to support markets by reinvesting cash from maturing bonds for an extended period after the Bank stops adding to its 2.6 trillion euro asset purchase program. On the interest rate front, he remained hopeful that a tighter labour market will help inflation to pick up and thus a rate hike could be delivered by the end of next year.
But markets are no longer fully convinced of the ECB’s guidance given the persisting weakness in data, US tariff threats on EU cars and the political noise in Italy, whilst the UK’s departure from the EU in March is considered another headache for business operations in the bloc. Still, if CPI figures beat expectations on Friday, displaying a stronger inflation, chances for a rate hike may improve, driving the euro even higher in the aftermath, especially if a lower than projected unemployment rate accompanies the CPI release – analysts believe that the unemployment rate has inched down by 0.1 percentage points to 8.0% in October, a level not seen since January 2009.
The euro has been printing lower highs and lower lows against the greenback from mid-September onwards mainly due to the Italian budget woes, falling as low as 1.1213 on November 12. An upside surprise in the CPI numbers – particularly in the core measure – is highly likely to support the common currency, with resistance probably coming first around 1.1350, the 23.6% Fibonacci of the downleg from 1.1814 to 1.1213. Steeper increases may also meet obstacles between the 38.2% Fibonacci of 1.1440 and the 50% Fibonacci of 1.1512.
On the other hand, a weaker inflation may boost speculation that the ECB may turn more cautious in its forward guidance on rates, pressuring the euro towards the 1.1200 round level. Below that mark, traders could look for support between 1.1118 and 1.1050
It’s worth cautioning though, that any headlines regarding Brexit, the Italian budget proposals and trade tensions could disrupt movements in the market.
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