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European Inflation: Enough to Resume Slide?

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European Inflation: Enough to Resume Slide?
The Euro experienced a bit of a relief rebound early on Monday following the election results in France. But uncertainty remains until the second round this weekend. And the data has been trending in line with expectations for more easing from the ECB. Is this the last bump higher before resuming the slide lower, or can the relief rally be sustained?

The Euro has been under pressure since early last month when the French President Emmanuel Macron surprised pundits and the market by calling a snap parliamentary election. Investors were worried what it might mean for the stability of the Euro if the far-right National Rally (RN) party were to win enough seats to form a government for the first time ever.

The Relief Rally

Exit polls showed that RN obtained the largest amount of popular support in Sunday’s election, but not enough to become a majority. The votes were in a three-way split, with Macron’s centrist faction falling to third place. France now goes to a run-off of the electoral seats that did not win an outright majority, which could number as many as 300, in a very unusual scenario. That keeps the uncertainty about what will happen in the coming election still quite high.

The run-offs feature three candidates, in many instances. That would favor the RN, gaining the largest number of votes, but not a majority. But if the third-place candidate were to decline to run, that would allow the second place to get enough votes to beat the right-wing party. The thing is, Macron’s centrist party is likely to be in that third place more often than not, and further undermine the President’s political base in Parliament. That generates additional uncertainty, as the left-progressive coalition is decidedly opposed to Macron as well.

Where the Euro Goes From here

The French election debacle comes in the middle of uncertainty about what the ECB will do. Having taken the first step in easing, the hawks have come back to be vocal about waiting to see what the effects have been. Meanwhile, the fast indicators of economic performance have been generally positive so far, suggesting that the ECB could have more room to hold out for another month.

Tomorrow’s release of CPI figures for the Euro Zone could be decisive in calculating the easing bias of the ECB. French inflation was lower than anticipated, which could mean that CPI change could continue to decrease even after the easing. That would make the case for a further cut stronger, with the consensus now forming around September for another 25 bps of easing.

What to Look Out For

Annual inflation for May in the Euro Area is expected to come down to 2.5% from 2.6% prior, which is still above the ECB’s target of 2.0%. The core rate is expected to be even higher, at 2.8%, but down from 2.9% prior.

As long as it keeps trending downwards, the market is likely to remain optimistic about two more rate cuts this year. But a beat of expectations on top of the situation in France could turn the Euro around for a while.

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