With EUR institutional positioning having shifted back into net short territory, the latest eurozone data will have further strengthened the conviction of bears with both inflation and economic sentiment having drifted lower.
Headline Inflation Falls Back
Headline CPI inflation for the Eurozone fell back to 2% in August from 2.1% prior, undershooting expectations of remaining at 2.1%. This weakness comes on the back of a strong rally in inflation over the first half of the year driven mainly by the surge in energy prices which posted a 9.2% rise in August alone after a 9.2% rise in July. However, as energy effects start to fade, inflation is now starting to slip and is likely to slip further over the coming months. Other components also posted weakness with services printing 1.3% from 1.4% in July and non-energy industrial goods printing 0.3% from 0.5% in July while food and tobacco remained stable at 2.5%.
Core Inflation Down
Core inflation also weakened, falling back to 1% in August, down from 1.1% in July and below expectations of remaining stable at 1.1%. The fall back in core inflation supports the view that the ECB was correct in its judgement to hold off on tightening monetary policy. The central bank has come under criticism over recent weeks from those suggesting that it is “behind the curve” when it comes to tightening. However, these latest inflation readings highlight that subdued inflation remains an issue in the eurozone economy.
Wage Growth Offers Hope
The ECB needs to see an improvement in core inflation to remain on course to end QE by year end and to raise rates by summer 2019. There is some hope for core inflation to rise though given the recent rally in wage growth. Q2 wage growth in the eurozone rose to 2.2% from 1.7% a year earlier, bring the reading up to levels not seen since 2012. This alongside the continued improvement in the unemployment rate suggests that the labour market recovery is starting to translate into wage pressures which should support core inflation over the coming months. The eurozone unemployment rate fell to 8.2% in August, from 8.3% in the prior month and is now at the best levels since the beginning of the last financial crisis.
Economic Sentiment Weakens
The Eurozone economic sentiment indicator fell to 11.6 in August, down from 112.1 in July as global and domestic concerned are weighing on the investor outlook. Concerns regarding the trade dispute between the US and the EU have dissipated somewhat over the last month following the talks between Trump and EC president Juncker, at which the two leaders declared their intention to work together to reduce trade barriers and tariffs.
However, there are still many concerns regarding the global trade environment as the dispute between the US and China intensifies. The service sector is especially worried about future demand given the current backdrop and the new orders indicator in the manufacturing sector is showing similar signs of distress falling to its lowest level in 12 months.
For now, there is little to suggest that the ECB is likely to tighten policy ahead of the currently projected “summer 2019” starting point and with data continuing to highlight weakness, the risk is that this date actually gets pushed out. With this in mind, expect EUR to grow increasingly sensitive to data as we head towards the year end and the ECB’s projected ending of QE.
After breaking down below the 1.1463 level support, EURUSD has since rallied back above the level where price is now consolidating which on the monthly chart has created an important technical development.
You can see on the chart above that price is putting in a bullish monthly pin bar after a series of inside bars. This highlights the potential for a strong reversal higher which, given the current weakness in USD, is particularly interesting and worth considering as we head into September which traditionally sees EUR strengthen against the Dollar (based on data from 1996 – 2015).