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Can EuroZone CPI Figures Derail the ECB’s Plans?

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Over the next couple of days, there will be a series of data releases that will be the first major test of the ECB’s resolve on interest rates. At the last meeting, the shared central bank effectively said that rates had topped out, barring any major change in the data. The main reason being that the Euro Area is facing economic stagnation if not outright recession, though the ECB didn’t put it as starkly as that.

After the meeting, ECB officials still talked tough on inflation, relying on keeping rates high for longer than raising them in order to knock down CPI increases. This rhetoric can have the effect of strengthening the Euro against the dollar – if the data conforms to expectations. The ECB would be able to maintain rates high for a long time as long as the economy stays at least marginally positive. A significant move into the negative for GDP, and the shared central bank might have to start cutting rates to prop up the economy.

It’ll keep coming down

The ECB’s plan of holding rates at the current level is based on a projection that core inflation will continue to fall through the rest of this year and all through next year. A couple of hiccups might be expected along the way, but anything suggesting a sustained trend higher would likely bring into question whether rates will go up again. That creates upside risk for the Euro against its peers, particularly for other countries that might be facing tougher economic outlooks.

A faster than anticipated drop in inflation, however, would lead to expectations that the ECB will be quick to cut rates in order to help the struggling economy to lift off. But many analysts think that situation is unlikely, particularly given the ongoing war in Ukraine. Crude prices have been rising recently, suggesting that inflationary pressure could come back. The EU still is facing higher food prices as well. In the shorter term, summer sales come to an end, and that could also push up headline inflation. If that is sustained for long enough, it will start to affect the core rate and put more pressure on the ECB to tighten in some way.

What the data is expected to say

Spain already reported its third consecutive increase in inflation for September. Spain was seen as the poster child for getting inflation under control, as it saw its headline and core inflation rates fall back to the ECB’s target. However, that was thanks to generous subsidies by the government which are now running out, and allowing inflation to rise.

All eyes are now on Germany, as the largest economy in Europe, which is facing economic stagnation. Normally, slow economic growth translates into less inflation, but the EU is facing generally external inflationary pressures. It’s imported goods such as energy, raw materials, and food that are raising prices. Nevertheless, Germany is expected to see a dramatic drop in its headline inflation to 4.8% from 6.1%. Which would normally be comforting to markets, except it’s expected to be largely attributed to base effects from last year. The monthly rate is seen accelerating to 0.5% from 0.3% prior.

Friday sees the results from the entire Eurozone, which is expected to see a slowing of inflation, but not as large as in Germany. That’s because other countries, like France and Spain, are seeing prices rising at a faster rate. EuroZone annual CPI is expected to come down to 4.7% from 5.2%, while the core rate is seen being a little more sticky at 5.0%, down from 5.3% prior.

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