Markets eye inflation estimates amid ECB rhetoric

EUR/USD found modest buyers in early European trade, rallying to a high of 1.3571, before sellers moved in as European equities came under pressure.

On the daily chart, EUR/USD seems unable to close above the 50% retracement of the October-to-November sell-off at 1.3564, while on the hourly chart there is good supply between 1.3560 to 1.3580 (see below). Comments from ECB member Benoit Coeure seem to be behind the move higher. Despite his comment that the ECB could cut the deposit rate to a negative print, the markets have shown no reaction. They have heard this line many times lately, and have chosen to rally on the statement that the central bank doesn’t see disinflation deepening.

Inflation expected to move towards target

Mr Coeure also mentioned that there is only so much the ECB can achieve within its mandate, and that inflation should gravitate back to the bank’s target of 2%. The comments on inflation are key for the ECB, and thus the euro, and fit in nicely with recent comments from the Bank of Spain governor, who said there is no risk of deflation in his country. Traders now await the eurozone CPI estimate on Friday, and the market expects a slight uptick to 0.8% from 0.7%. However, with the risk of further disinflation present, it’s hard to believe we will see significant upside for the euro ahead of that print.

Impact of eurozone CPI

It’s important to remember that in the last eighteen months the CPI estimate has only deviated once from the ‘final’ CPI print, and this was revised by meagre 0.1%. So any number below 0.7% should push the euro lower, especially given the barrage of comments from the likes of ECB member Joerg Asmussen, and now Benoit Coeure. They have been trying to talk down EUR/USD by issuing threats that the bank can cut the deposit rate to a negative print. Before the bank resorts to such extreme measures, it will need to see more intense deflationary forces.

Political risks

Aside from the inflation picture, which has subsequently elicited dovish language from various ECB officials, I think it’s also interesting to keep an eye on developments in Greece. The Greek government seems to be pushing back on demands from the Troika to reduce state-owned assets. Opinion polls continue to look more favourable for the extreme right-wing Golden Dawn party, and this feeds into my view that political risks remain one of the key concerns for Europe over the coming years. Of course, France is another country which fits into this view. This topic seems to be of little concern to the market at the moment, but I feel it deserves close attention.

Spot FX EUR/USD chart

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