Normally, inflation data like what we will get out of the EuroZone over the next couple of days, especially the November CPI, is pivotal for currencies. And that might still be the case, if the data comes significantly out of line from expectations. But Europe is facing a gathering storm that might push the EURUSD down to and beyond parity, with monthly inflation at most being a bump along the way.
The recent decline in the shared economy has largely been attributed in the media to the reelection of Donald Trump. But Europe has plenty of internal issues besides that, which explains why the EURUSD started its descent as far back as late September. November was just the latest leg down. The question now is whether that will continue, or there is a chance of a rebound.
It’s Not Just One Factor
The EuroArea is dealing with an economic slowdown on top of a series of political crises that have impeded a robust fiscal resolution to the problem. This has left many traders and investors looking toward the ECB for a solution. That would mean cutting rates, despite inflation expected to tick up over the next few months. Members of the Governing Council that sets rates have shown to be clearly divided on the issue.
Depending on which side gets emphasized, market pricing of a quarter- or half-point rate cut has fluctuated. Through most of November, the consensus was more inclined towards the bigger cut. That has moderated a bit, but the Euro has continued to slide as investors worry about the potential impact of tariffs on a shared economy that is already fractured, both economically and politically. In other words, European leaders might not even agree on how to handle tariffs, let alone how to rekindle the economy.
More Spending, More Inflation
Earlier this month, the German governing coalition collapsed in an argument over whether to increase spending. The political fate of France’s Prime Minister also hangs in the balance over spending. Europe has long struggled with some countries having high fiscal deficits which push inflationary pressures, and fiscally conservative countries led by Germany insisting on spending prudence and currency stability.
But with Germany now so in need of stimulus to the point that even former Chancellor Angela Merkel is arguing for raising spending, the fiscal rock might be cracking. That would mean the hawkish block could stand bank, allowing for lower rates in an effort to support the economy. Lower rates imply a weaker currency. Increased spending implies a weaker currency if the central bank is seen easing up on its efforts to control inflation.
How the Market Could React
The market seems to be moving to a consensus that the ECB is shifting away from its focus on inflation towards supporting the economy. After all, ECB President Lagarde has said in the past that inflation is expected to pop up in the fourth quarter before settling back down, anyway. That means investors might look past the CPI data if it’s in line, and instead focus on PMIs that come out next Monday. Unless there is a significant bump up in the inflation to cause a rethink of the situation.
Headline Flash November CPI for the EuroZone is forecast to pop back up to 2.3% from 2.0% in the prior month, mostly on the back of higher fuel prices. The recent cold snap accompanied by slower wind has caused a drop in Europe’s natural gas stores, and a spike in international LNG prices. That would contribute to the temporary notion of inflation, as those costs would be expected to revert when the weather improves early next year.
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