The flash reading of July CPI for the Eurozone will come out on Friday, as the ECB sets off on a new course of action. The EURUSD has been declining this week, but that has been chiefly attributable to events in the US. The question is whether Euro Area data can put a floor under the currency, or is it downhill from here?
The decline in the Euro is also somewhat ironic since at the last meeting, monetary policy was kept unchanged. The ECB had been on a year-long easing campaign, which culminated in the Euro at multi-year highs. Now that the shared central bank has paused its easing, with considerable uncertainty about further easing, the Euro seems to be weakening.
It’s Still the Economy
Following last week’s policy meeting, the ECB’s survey of professional forecasters came out. It said that inflation was likely to be around 2.0% for the rest of the year, which is lower than the 2.2% that the ECB’s latest projections have. This means the shared central bank could cut its inflation outlook, putting further downward pressure on the Euro. The survey also said it expected inflation to fall to 1.8% in the following year.
The issue comes down to economic growth, since expanding GDP is what drives organic inflation. The opinion at the ECB is that the current interest rate is “neutral”, meaning it neither stimulates nor holds back the economy. But if the economy doesn’t grow fast enough, then inflation would sink below target. This would then require the ECB to resume rate cuts.
The Peak for the Euro?
The recent rise in the Euro was not primarily due to interest rates. Instead, traders were worried that the US economy would underperform. This made investing in Europe (like buying stocks) more attractive. So, traders started buying Euros, pushing the price up. The main reason for the US to underperform, in this way of thinking, was because of tariffs and uncertainty around the trade war.
Now that the US and the EU have reached a trade deal, the uncertainty is fading. Also, US Q2 GDP came in above expectations and faster than the EU. So far during earnings seasons, more EU companies have cut guidance than American ones. If the ECB keeps rates unchanged, that would mean it’s not stimulating the EU economy. With slower growth in equity indices, investors might start thinking about moving assets back into dollars and reverse the recent Euro gains.
What to Look Out For
Euro area Flash July inflation is projected at 1.9% slightly lower than the 2.0% of a month ago. That’s practically in line with the ECB’s 2.0% target. The core inflation rate is expected to tick down to 2.2% from 2.3% previously.
The issue might lie in the breakdown of where the inflation is coming from. Last month saw services inflation at 3.3%. That was offset in part by lower energy costs and cheaper imports as the Euro remained strong. The ECB has been particularly concerned about services inflation lately. If prices for services keep rising quickly, then the central bank might keep signalling no rate cuts, counterintuitively weakening the Euro in the near term.
