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Euro surges as Eurozone inflation cools

Home >  Daily Market Digest >  Euro surges as Eurozone inflation cools

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Written by:
Myrsini Giannouli

02 June 2023
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Important calendar events

  • JPY: Monetary Base
  • EUR: French Industrial Production, Spanish Unemployment Change
  • USD: Average Hourly Earnings, Non-Farm Employment Change, Unemployment Rate

USD

The dollar weakened on Thursday, with the dollar index dipping to the 103.5 level. US Treasury yields also retreated, with the 10-year bond yield dropping to 3.60%.

Concerns about a potential US debt default have been causing economic uncertainty, affecting dollar prices. US Treasury Secretary Janet Yellen has warned that the office will not meet all US government obligations by June 5th. This would force the country to default on its debt, leading to a major recession. 

US President Joe Biden and Republican House Speaker Kevin McCarthy have been negotiating a deal that would raise the government's debt limit, preventing the US from going into default. The two parties have reached an agreement to suspend the federal government's $31.4 trillion debt ceiling. The deal, however, will have to be approved by Congress before the US runs out of resources to meet its obligations. The deal passed the House of Representatives by a strong vote of 314–117 and was sent to the US Senate for approval. Senators are racing to pass the debt limit bill as the threat of default looms. US lawmakers will be called to assess the deal with little time to spare.

The state of the labor market may affect the upcoming Fed interest rate decision later this month. ADP Non-Farm Employment Change on Thursday came in at 278K in May from 291K in April, exceeding expectations of a 173K print. Unemployment claims were unchanged this week, rising slightly to 232K from 230K last week.

ISM Manufacturing PMI data on Thursday fell below expectations. Manufacturing activity dropped to 46.9 in May from 47.1 in April, against the 47.0 predicted. The US manufacturing sector contracted for the sixth consecutive month in May, with a print below 50 indicating industry contraction. Disappointing manufacturing data may influence the Fed to pause rate hikes this month to support the ailing US industry. In addition, ISM Manufacturing prices plummeted to 44.2 in May from 53.2 in April, against expectations of 52.4. Reduced manufacturing costs could help ease inflationary pressures, removing some of the burden on the Fed to sustain its hawkish policy.

Fed rhetoric earlier this week was relatively hawkish, raising doubts about a pause in rate hikes. FOMC member Loretta Mester stated that she sees no reason to stop raising interest rates yet. Later in the week, however, Fed’s Jefferson and Harker advocated for keeping interest rates the same this month.

US Federal Reserve Chair Jerome Powell has also indicated that the US Central Bank may pivot in a more dovish direction. The Federal Reserve raised interest rates by 25 basis points at its latest monetary policy meeting, bringing the benchmark interest rate to a 16-year high target range of 5.00% to 5.25%. 

Markets anticipate a pause in rate hikes in June. The US Central Bank has signaled that its hawkish policy is coming to an end, as prolonged tightening is putting the economy at risk and the recent turmoil in the banking sector has increased recession concerns. Many analysts predict a high probability of rate cuts starting in November, depending on economic conditions and inflationary pressures. 

The US economy expanded by 1.3% in the first year of 2023, against predictions of 1.1% growth. The preliminary GDP Price Index, which is an important inflation gauge, exceeded expectations, rising by 4.2% in Q1 of 2023 versus the 4.0% anticipated. 

US headline inflation dropped to 4.9% year-on-year in April, decelerating from a 5.0% print in March. US inflation cooled more than expected in April, as markets were anticipating a 5.0% print. 

The US Core PCE Price Index, however, rose 0.4% every month in April, versus a forecast of 0.3%. Core PCE, which is the Fed’s primary inflation gauge, went up by 4.7% year-on-year in April, having gained by 4.6% in March. Inflationary pressures in the US remain sticky, suggesting that the Fed may have to persist with its policy of monetary tightening to restore price stability.

Several important labor indicators are due on Friday, especially Non-Farm-Payrolls. The release of these data may cause volatility in dollar prices. Estimates are pointing to a slightly lower print on Friday’s employment figures, which may suggest a weakening labor market.

TRADE USD PAIRS

EUR 

The euro gained strength against the dollar on Thursday, and EUR/USD surged to the 1.075 level. If the currency pair goes up, it may encounter resistance near 1.083. If the EUR/USD pair declines, it may find support at 1.063.

Signs of cooling Eurozone inflation boosted the euro on Thursday. Headline inflation registered its lowest print since February 2022. Flash CPI cooled to 6.1% year-on-year in May from 7.0% in April, beating expectations of 6.3%. Core inflation, which excludes food and energy, also slowed to 5.3% on an annual basis in May versus 5.6% in April and a 5.5% forecast. The latest inflation print is showing that the ECB’s efforts to bring inflation down are paying off, but it will likely not be sufficient to induce the central bank to abandon its hawkish policy just yet.

The ECB released its latest Financial Stability Review on Wednesday, which highlights that Euro Area financial markets remain vulnerable and that tighter financial conditions are testing the resilience of Euro Area firms, households, and sovereigns. The report also warned that recession fears may return.

The ECB raised interest rates by 25 bp at its latest monetary policy meeting, bringing its main refinancing rate to 3.75%. The ECB raised interest rates by 50 basis points in previous meetings and is slowing down the pace of rate hikes. 

The ECB has left the door open for further rate hikes as inflationary pressures in the EU remain high. The ECB, however, is expected to reassess its policy direction ahead of its next meeting in June. EU policymakers must take a lot of variables into account, including the effect of economic tightening on the now fragile banking sector.

ECB President Christine Lagarde has stated that the ECB is approaching a critical juncture and that further action is necessary to bring inflation down to the bank’s 2% goal. Lagarde’s comments point to further rate hikes ahead, while the US Fed has signaled a pause in rate hikes.

Price pressures in the Eurozone remain high. Headline inflation rose to 7.0% year-on-year in April from 6.9% in March, in line with expectations. Core CPI, which excludes food and energy, dropped slightly to 5.6% on an annual basis in April from 5.7% in March. Eurozone inflation is not showing signs of cooling despite the ECB’s aggressive tightening.

GDP Flash data for the first quarter of the year showed that the Eurozone economy expanded by 0.1%, registering a small improvement against the 0 print for the final quarter of 2022.

EURUSD 1hr chart

TRADE EUR PAIRS

GBP 

Sterling gained strength against the dollar on Thursday, and GBP/USD was catapulted to the 1.252 level. If the GBP/USD rate goes up, it may encounter resistance near 1.268, while support may be found near 1.230.

Mortgage approvals released on Thursday dropped to 49K in April from 51K in March, versus 54K expected. British lenders approved fewer mortgages in April than in March. Net Lending to Individuals also dropped to 0.2B in April from 1.6B in March, falling below expectations of 2.2 B.

Headline inflation in the UK dropped below 10% on an annual basis in April for the first time since August 2022. The CPI data released last week revealed that inflation in the UK is starting to cool, although not as rapidly as anticipated. Headline inflation rose by 8.7% year-on-year in April from 10.1% in March, surpassing expectations of 8.2%. Core CPI, which excludes food and energy, rose to 6.8% annually in April from 6.2% in March.

BOE governor Andrew Bailey has warned that inflation in the UK is persistent and will require further tightening to bring inflation to target. The BOE raised interest rates by 25 basis points at its latest meeting in May, bringing the bank rate to 4.5%. Market odds are in favor of more BOE rate hikes up ahead, and many analysts predict no rate cuts at all within the year. The BOE has been following an aggressively hawkish monetary policy, aiming to bring inflation down. 

The British economy contracted by 0.3% in April, after registering stagnation in March. The International Monetary Fund, however, upgraded the UK’s growth prospects, stating that a recession was now unlikely. The IMF had previously forecast that the British economy would contract by 0.6% this year. 

The UK’s weak economic outlook limits policymakers’ ability to increase interest rates sufficiently to rein in inflation. The British economy is struggling, and policymakers will have to assess how much tightening it can withstand to bring inflation down.

GBPUSD 1hr chart

TRADE GBP PAIRS

JPY

The Yen extended gains on Thursday, and USD/JPY dropped to 138.8. USD/JPY had been moving close to a six-month peak earlier this week. If the USD/JPY pair declines, it may find support near 137.4. If the pair climbs, it may find resistance at 142.5. 

A senior official at the Ministry of Finance reported earlier in the week that financial authorities met in response to the weakening of the yen. Japanese authorities are closely watching the currency market and have stated that ‘currency rates should move stably reflecting fundamentals’, and that ‘excessive volatility is undesirable’. The Yen gained strength in response to this announcement, as short traders worried about a potential intervention from the Japanese government to support the yen.

The BOJ decided to continue its dovish monetary policy at the bank’s latest meeting in April. This was the first meeting with the newly-appointed BOJ Governor, Kazuo Ueda, at the helm. Japanese policymakers maintained ultra-low interest rates at the BOJ policy meeting, keeping the central bank’s refinancing rate at -0.10%. 

Ueda reaffirmed his commitment to the bank’s ultra-loose monetary policy earlier in the week. Ueda stated that monetary policy would remain accommodative until the bank’s 2% inflation target became sustainable. He also predicted that price pressures would fall sharply in the next year.

BOJ Core CPI rose to 3.0% year-on-year in April from 2.9% in March. April’s print exceeded expectations of 2.8% growth, indicating that price pressures in Japan continue to rise. The Tokyo Core CPI for April was also hotter than expected, at 3.5% on an annual basis, against expectations of a 3.2% print. Inflation in Japan remains steadily above the BOJ’s 2% target, putting pressure on businesses and households. Increased price pressures and wages raise concerns about a wage-price spiral and may force the BOJ to pivot towards a more hawkish policy.

Preliminary GDP data for the first quarter of the year were optimistic, showing that the Japanese economy expanded by 0.4% in Q1 of 2023 after reaching stagnation during the last quarter of 2022. The GDP data exceeded expectations of 0.2% growth in the first quarter of the year, alleviating recession concerns for Japan. The final GDP Price Index printed showed a 2.0% annual expansion, versus 1.2% the previous quarter. Japan’s economic recovery increases the odds of a hawkish pivot in the BOJ’s monetary policy. 

USDJPY 1hr chart

TRADE JPY PAIRS

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Written by:
Myrsini Giannouli

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