Markets are essentially anticipating the ECB to stay on the sidelines for the rest of the year. But that might change at any moment if the data comes in as a surprise. Last month’s inflation was bang on the ECB’s target of 2.0%. President Christine Lagarde was pleased to report that consumer prices were in a good place last week. That means the current outlook for European monetary policy relies on the data matching expectations, and inflation not deviating too much from the target.
The problem the ECB is facing now is not directly within its mandate: Europe’s lack of growth. It’s not the central bank’s responsibility to drive economic growth. However, if the economy stagnates or slips into a technical recession, inflation can fall below target. And that’s a significant concern for the ECB, as it spent years fighting a slow-growth, slow-inflation environment. There are plenty of members of its board who are eager to cut rates at the first sign of inflation underperformance, which could weigh on the Euro.
What the Market is Looking For
At first glance, that doesn’t seem to be a problem for now. In fact, the consensus among economists is that the Euro Area’s September preliminary CPI is projected to rise to 2.3% from 2.0% in the previous month. That would match the 2.3% of the core rate, which is expected to remain unchanged. Higher food prices are seen as the primary reason for the increase in consumer prices in September.
However, before that data is released, the market can get a better idea of whether the CPI figure will beat or miss expectations from the large economies that report a day earlier. French inflation is expected to rise to 1.3% from 0.9% on Tuesday, and German inflation is also projected to increase to 2.3% from 2.2%. It is worth noting, however, that flash PMIs from both countries disappointed last week, which could be a sign that the expected increase in inflation may not materialize.
Gauging the Market Reaction
The European CPI is often not a significant market mover, given that components from individual countries are released well in advance. It usually takes a significant surprise to jolt markets in the moment. And that’s when there is anticipation that the ECB might take action. Nevertheless, it’s a key data point that can influence the trend for the Euro in the coming weeks and even months.
What’s relevant for the EURUSD is how this compares with the Euro’s counterpart, the dollar. While the ECB is projected to keep rates unchanged as inflation stays on target, the Fed is projected to cut rates to support the economy despite inflation being above target. Typically, this would weigh on the greenback and support the EURUSD.
The Market Doesn’t Like Surprises
The expectation, ever since the EU and the US reached a trade deal that avoided European tariffs in retaliation for Trump’s tariffs, was that inflation would remain subdued. So, rising consumer costs could pose a challenge to analysts’ forecasts for the Euro.
The Euro has been gaining strength thanks to expectations of a faster-growing economy. But, if inflation rises, and the ECB is forced to raise rates, then this could slow if not kill the meagre growth in the Eurozone. In that scenario, the widening interest rate gap could, counterintuitively, weigh on the EURUSD.
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