Euro Holds Gains After Eurozone Inflation Comes In Below 3.0% But Core Remains 'Sticky'

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Eurozone inflation is back below 3.0% but core CPI nearer 4.0% will keep the ECB guarded and Euro supported.

The FX textbook says the Euro should rise when inflation data beats expectations, as this boosts the odds for more bond yield-supporting interest rate rises at the European Central Bank (ECB).

But this is no longer the case: the euro is riding high in the wake of Eurozone CPI data for October, suggesting rapidly falling inflation is now outright supportive.

Inflation data from Germany, France, Portugal and Spain all came in below expectation, leading to an all-Eurozone CPI inflation print of 2.9% year-on-year in October, down from 4.3% in September.

This puts it comfortably below the level of 3.1% anticipated by the market and could allow the ECB to ease monetary conditions by cutting interest rates earlier in 2024 than had previously been antcipiated.

But maybe it is too soon to expect the ECB to call the all-clear on inflation: Eurostat reported Core CPI inflation fell to 4.2% from 4.5% previously, putting it in line with analyst expectations.

"Euro area inflation dropped more than expected again in October, falling below 3% for the first time since mid-2021. The ECB will hold this news at arm’s length. Core inflation remains above 4%, twice the target level of inflation. The ECB needs to see wage inflation slowing and this could take a further six months," says Mark Wall, Chief European Economist at Deutsche Bank.

The elevated rate of CPI core inflation will therefore offer some support to Eurozone bond yields, which can offer Euro exchange rates ongoing support.

"Don’t expect the ECB to lower rates anytime soon... the ECB will be very keen to avoid making the mistake of the 1970s by easing too soon and allowing another spell of high inflation later," says Bert Colijn, Senior Economist for the Eurozone at Nordea Bank.

But the falling headline inflation rate to below 3.0% is also supportive of the Euro it eases pressure on Eurozone businesses and consumers, improving the economy's prospects which is ultimately the surest guarantor of currency valuation.

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Valentin Marinov, Head of G10 FX Strategy at Crédit Agricole, reminds us of an old adage when discussing the Euro's performance: "It's the economy, stupid."

"The latest inflation data together with somewhat better-than-expected Q3 GDP numbers have helped ease the Eurozone stagflation fears in a boost to the appeal of EUR-denominated assets," says Marinov.

The Euro to Pound Sterling exchange rate hit a new five-month high on Tuesday as it went on to touch 0.8746, equating to a new multi-month low for the Pound to Euro rate at 1.1433.

The Euro to Dollar exchange rate is up a quarter of a per cent at 1.0650 and increasingly looks as though it has exited the July-October selloff.

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The Euro lost some of its shine, however, on the release of official Eurozone GDP figures for the third quarter, which came in below expectation at 0.1% year-on-year in the third quarter, down from 0.5% in the second quarter. The market was looking for 0.2%.

This was after the quarter-on-quarter change was -0.1%, which is down on 0.1% in the second quarter and below the 0% the market was expecting.

Nevertheless, "today’s data could help further ease market stagflation concerns, especially if global energy prices remain under pressure," says Marinov.

"This morning's release of Eurozone GDP data, and the (lack of) market reaction, may tell us something about how hard it is for the euro to fall all that far from here," says Kit Juckes, Head of FX Research at Société Générale. "A lack of growth is priced in already."

Juckes cautions against assuming that "the euro is safe... the risk is that we continue to see (as has been the case for the last few weeks) ECB cut expectations grow for mid-2023, while Fed expectations stick to the ‘high for longer’ mantra."

"That can still take EUR/USD closer to parity," he adds.