Tuesday sees potentially the most important data release for the most traded Forex pair: the Eurozone March CPI. That’s because there is considerable disagreement in the market over what to expect from the ECB next month, and the inflation data is expected to be the deciding factor. Markets could react ahead of the data release as partial figures from constituent countries are released.
There is a disagreement between traders and economists on the policy outlook for the Eurozone. Around two-thirds of economists polled after the war in the Middle East started say they still expect the ECB to keep rates unchanged this year. This is fewer than the 90% that said the same before the war. And the dissenters have changed direction; the 10% in February expected a cut, while the 40% dissenters now see a hike.
The Market Pricing In Rate Hikes Soon
The relatively unchanged views of economists contrasts with the large swing in the markets. Traders are pricing in at least 50bps of hiking by the end of the year, with around 50% odds of a third hike. There is around a 40% chance of a rate hike as soon as April, with ECB officials confirming that it is on the table. But whether the ECB will pull the trigger or not depends on how much inflation effect is already being seen in the first official data since the war began.
The concern is that it will take a few weeks or even months for the full impact of higher crude to show up in the March CPI data. That’s why a large jump already in March could mean trouble further down the line as inflation keeps rising in the subsequent readings. In that case, the ECB might feel compelled to raise rates sooner to head off a rise in CPI and avoid the criticism it received back in 2022 for failing to act soon enough.
Higher Rates are Bad for the Euro
Typically, a rate increase would support yields and also the currency. But, that is under normal circumstances of organic inflation driven by a growing economy. The concern now is that higher fuel prices will raise business costs, and depress growth. If on top of that, the ECB raises rates, the higher borrowing costs would slow down the economy even more. This makes Euro-denominated assets even less interesting for investors, who will look for other economies to get a better return, selling the Euro in the process.
Markets are expecting an initial uneven impact from higher prices, with periphery nations seeing higher inflation than central nations. This is in part due to higher price regulation in countries like Germany, which slows the transmission of inflation to consumers.
What the Market is Looking For
Spain already reported its flash March CPI on Friday, with a jump in the annual rate to 3.3% from 2.3% in February. On Monday, Germany will report its flash headline reading, anticipated to jump to 2.6% from 1.9% in the prior month. Both of those are well above the ECB’s 2.0% target.
The consensus is for Eurozone flash March inflation to rise to 2.7% from 1.9% in February. But the market could take its cues from the German figures if they come in line with expectations. If inflation is below forecasts, it could leave the ECB with more room to delay rate hikes, and that might actually suppor the Euro.
