Eurozone deflation, PMI slump point to ECB action, yet euro is soaring – Forex News Preview


Raffi Boyadjian, XM Investment Research Desk

The flash prints for November inflation are due out of the Eurozone on Tuesday (10:00 GMT) along with a host of other data that should provide the latest glance on how the economy is faring. The inflation numbers are expected to reveal that the euro area experienced falling prices again in November, while the final PMI readings will probably confirm that business activity shrank during the month. The deteriorating economic conditions come as the euro is flirting with the key $1.20 level and policymakers at the European Central Bank are pondering their next move.

Eurozone prices set to fall again

The pandemic-induced depression-like downturn has choked off what little inflationary pressures the ECB had managed to revive after years of ultra-easy monetary policy. Although inflation for manufactured goods has now started to pick up, social distancing rules are depressing prices for a vast array of services that rely on footfall for profitability. This would go some away in explaining why underlying measures of inflation have also fallen dramatically in recent months and why the ECB should be more worried than it is letting on.

The harmonized index of consumer prices (HICP) for the euro area is forecast to have ticked up slightly to -0.2% year-on-year in November, making it the fourth straight month of negative inflation. When excluding volatile items such as food, energy, tobacco and alcohol, HICP is projected to hold at +0.2% y/y, which is a record low for this particular measure of core inflation.

Gloomy data ahead of ECB meeting

No revision is expected to the final readings of IHS Markit’s PMIs out on Tuesday (manufacturing) and Thursday (services).  The preliminary readings showed the composite PMI fell below 50 for the first time since June, signalling the Eurozone could be headed for a double-dip recession. Wednesday’s unemployment rate and Thursday’s retail sales figures will also be eyed for fresh clues on the health of the Eurozone economy.

The sharp and sudden faltering of the recovery is likely to dominate discussions at the ECB’s policy meeting on December 10 when the central bank is highly anticipated to beef up its pandemic emergency programmes. However, having already expanded and extended their emergency asset purchases once, policymakers may refrain from making significant changes to this programme so soon.

Euro testing $1.20 as Fed may outdo ECB

That may be one reason why the euro has been on a bit of a bull run during November, as investors are pricing in more aggressive easing by the Federal Reserve in comparison to the ECB, which is pressuring the US dollar.

If this week’s data are more or less in line with expectations and point to modest action by the ECB next week, euro/dollar could next set its sights on the 1.2080 resistance if it manages to successfully overcome the psychologically important 1.20 barrier. Meanwhile, prolonged dollar selling would pave the way for the 1.2264 level, which is the 161.8% Fibonacci extension of the September-November downleg.

However, in the event that the upcoming releases point to a lot more pain for Europe’s economy and ECB officials begin to publicly fret about the euro rising above $1.20, the pair would be vulnerable to a downside correction. Initial support from any selloff may be found at the 78.6% Fibonacci retracement of 1.1923. A deeper slide could see the 20-day moving average, which coincides with the 61.8% Fibonacci of 1.1855, coming into focus.