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EuroZone Inflation and Potential Inflection for the ECB

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Volatility for the EUR/USD might continue through the rest of the week as the pair is buffeted by a barrage of data. The dollar’s strength has pushed the pair down, but the data hasn’t been all that good for the Euro. Though that might change with the upcoming figures, as the ECB faces an increasingly complicated scenario.

Stagflation as a concern is back on the menu. This after the latest PMI reports confirmed that the shared economy has seen manufacturing production contract for a year and a half straight. The PMI figures reported on Tuesday point to the Euro Zone having fallen into a recession in the latter half of 2023.

Getting Prices Under Control

That would normally be good news for the fight against inflation. Slower economic activity typically comes with a drop in consumer demand, and therefore prices. But that doesn’t seem to be the case this time around, with inflation expected to return to rising in December. Coming after the ECB promised to not raise rates, it might be seen as a sign that the doves won too early.

Whether or not it will be enough to push the ECB hawks back into pole position is another question. Especially since the core rate is expected to keep coming down. Which might open an interesting shift in rhetoric out of officials of the shared central bank. Up until now, the dovish members have been championing the headline number for reference. But now that headline inflation is expected to rise, they might change their tune and say that more focus is needed on the core.

A Blip, or a New Trend?

Those hoping that the ECB will stay on the hold-to-easing track could say that one data point doesn’t mean a new trend is forming. Coming amidst the holiday sales season, and the increase in crude prices due to geopolitics, the increase in headline inflation might be transitory. But, a beat over already high expectations could generate buzz about the ECB staying on the tightening track for longer. That could support the Euro. On the other hand, a miss in the data could keep the downward trend for the EUR/USD going.

The volatility will likely start on Thursday when France and Germany, the two largest economies in Europe, report their respective inflation numbers. France will be first to report, and is expected to show annual headline inflation rising to 3.8% from 3.5% prior. Germany will report a couple of hours later, and there the change is expected to be even more dramatic. Europe’s largest economy is expected to see its December inflation rate jump to 3.7% from 3.2% prior.

Where Things Could be Going

The EuroZone then reports its preliminary December CPI on Friday, with the headline rate expected to rise to 2.9% from 2.4% prior. That’s a substantial move away from the 2.0% target. The core rate – excluding energy and food costs – is expected to keep its downward trajectory and come in at 3.4% compared to 3.6% prior.

A blip up in the headline inflation rate normally wouldn’t be a major event. But given the slowing of the shared economy, it might be an issue for more concern. However, the long-term effects on the currency might be limited, as trades speculate that the ECB might focus more on the lack economic dynamism instead of the rising prices.

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