On Wednesday 30th April at 1000 BST/ 0500 ET the Eurozone’s flash CPI estimate for April will be released. The market is expecting an increase in the headline rate to 0.8% from 0.5% in March, and for the core rate to also rise to 1% from 0.7%. Price data is crucial for the currency bloc after months of sub 1% price growth, it is a key focus for the EUR as speculation has increased that the ECB will embark on QE at some stage this year to combat disinflation.
We think that the bar to QE from Draghi and co. at the ECB is high, and this month’s price data will be crucial for the next policy step from the central bank. The currency bloc has been lingering in disinflation since prices dropped below the ECB’s target rate in early 2013. Price declines have accelerated in recent months and in March prices dropped to a 2009 low.
This is problematic for the ECB since price stability is its only mandate. While the ECB has been tolerant of 14 months of falling prices, we believe that 0.5% could be a line in the sand. If prices fall further it could be forced to take action.
A lot resting on April data
At the ECB meeting earlier this month, the ECB’s Draghi mentioned that prices should move higher due to the Easter holiday, which last year fell in March. This tends to trigger price increases in air travel and package holidays. Food price inflation may also rise, which could reverse some of the 0.5% decline in March. If prices do move higher as expected, this could ease the pressure on the ECB to take further action in the near term, but what about price stability beyond April?
Expectations are for more fluctuations in prices in the coming months, with the risks rising for further downside. Food prices are expected to decline throughout the summer, while energy prices could also slide as we move into the warmer months. Thus, one month of rising prices may not a trend make, although things are expected to look brighter next year as growth picks up, triggering prices to rise.
The road ahead for the ECB may not be that clear-cut; for example, if it decides to keep policy on hold in the expectation that prices will rise next year then it could be blamed if prices fall further and the pick-up in growth does not go according to plan. However, if the ECB embarks on a radical policy step like QE it may stoke a potential inflation bubble down the line.
National Split:
Interestingly, Germany, which is traditionally a low-inflation country, has seen prices rise in recent months, while typically high inflation countries like Italy and Spain have seen prices moderate sharply. German prices are the most important for the overall currency bloc, as they make up 27.7% of total Eurozone HCIP, and in April prices rose less than expected to a 1.3% annual rate, which is probably enough for overall Eurozone inflation to rise to 0.8%.
It’s not easy to be a central banker, and policy mistakes are depressingly common. We believe that a reading of 0.8% could keep the ECB on hold at its meeting on May 8th; however a negative surprise could force the ECB’s hand to embark on a loosening of policy in the near-term.
We believe negative deposit rates are more likely than QE at this stage, especially after data showed that lending to the private sector contracted at an annual rate of 2% in March, its sharpest fall on record.
The EUR effect:
We mentioned that inflation could be the key driver for EURUSD in the near term after volatility dropped to 7 year low earlier this month.
From a technical perspective, EUR/USD sold off on the back of the weaker than expected German inflation figures on Tuesday. We may see further declines if overall Eurozone inflation is also weaker than expected. The technical signals also suggest that this pair is vulnerable after it failed to break above Monday’s high at 1.3879.
The downside is being capped at 1.3805 (50-day sma) for now, however, below this level opens the way to 1.3762 – the 61.8% Fib retracement of the latest recovery, and then 1.3664 – the 61.8% Fib retracement of the February to March advance.
Takeaway:
- Price data will be key for the direction of the EUR this week.
- Although Eurozone prices are expected to rise in April, they could moderate later this year.
- We agree with consensus and expect a 0.8% reading, which could justify the ECB remaining on hold at its May meeting.
- A reading sub 0.5% could trigger policy action from the ECB, we believe that negative deposit rates are more likely than QE at this stage, both would be negative for the EUR.
