European inflation data unlikely to do the euro any favors – Forex News Preview

Marios Hadjikyriacos, XM Investment Research Desk

Preliminary CPI numbers for September out of the euro area will attract attention on Tuesday at 09:00 GMT. Forecasts suggest that inflation rose at the same pace, but the bloc’s weak PMI surveys imply that if there is any surprise in these figures, it may be a negative one. The euro is already trading at multi-year lows, and any disappointment could be the catalyst for further weakness. For this bearish tide to turn, markets may need to see signals for powerful fiscal stimulus, which is unlikely for now.

The Eurozone is quickly becoming the ‘problem child’ of the global economy. Economic growth in the currency bloc has slowed dramatically, as the US-China battle and growing concerns of a disorderly Brexit have taken a toll on exports and business investment, bringing the manufacturing sector to its knees. Worryingly, the latest PMI surveys showed that the disease in manufacturing has also started to infect the far-larger services sector, threatening to sink the Eurozone into another recession.

Draghi, to the rescue?

The European Central Bank (ECB) has therefore stepped up, cutting interest rates further and relaunching another round of Quantitative Easing (QE) to stimulate the struggling economy. Outgoing ECB President Draghi argued that inflation was no longer on track to meet the central bank’s target, which warranted action. His main message, however, was that monetary policy has already reached its limits and that fiscal policy has to start doing the heavy lifting.

Downside risks

In this context, the upcoming inflation data for September will provide a glimpse into whether the ECB is likely to act again soon, or whether it will take a step back and watch the effects of its latest measures for a while. Forecasts suggest that both the headline and core CPI rates rose at the same pace as previously in September, at 1.1% and 1.0% respectively on a yearly basis.

However, those forecasts may be overly optimistic, considering that the Eurozone’s preliminary composite PMI survey for the month showed that “average prices charged for goods and services barely rose, registering the smallest increase since November 2016”. Therefore, if there is any surprise in the CPIs, it is more likely to be a disappointment.

Euro in the eye of the storm

The euro is already trading at 2½-year lows against the dollar and a negative surprise in these data may send the pair even lower, as the odds for more ECB action jump. Markets currently assign a 35% probability for another 10 basis points rate cut before year-end.

Taking a technical look at euro/dollar, further declines could meet support near 1.0830, a zone marked by the highs of February 2017. A downside break could see the bears challenge 1.0670, the inside swing high of April 2017.

On the upside, a recovery in the pair may stall initially around 1.0985, where a violation could see the buyers challenge the 50-day simple moving average (SMA) – currently at 1.1075 – and the downtrend line drawn from the highs of June.

No fiscal stimulus, no rebound

In the big picture, for the European economy to really turn around and hence for the euro to recover in a sustainable manner, substantial fiscal stimulus is probably needed. Monetary policy is exhausted, so even more action by the ECB – like greater injections of QE – would probably face diminishing returns in their success.

Unfortunately, the only major European economy with any real space for fiscal stimulus is Germany, and Berlin doesn’t like to run deficits. Therefore, the situation probably needs to deteriorate even further before any significant stimulus is rolled out, which implies that more pain may be in store for the euro before a lasting rebound can occur.