Euro Exchange Rates: Faltering Economy to See ECB Interest Rate Guidance Binned say Economists 

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- EUR gives up gains after industrial data confirms torrid Q4 for economy.

- Germany, Italy may be in recession and Eurozone growth is falling fast.

- Economists say ECB rate hike guidance likely to be thrown in bin soon.

The Euro was soft Monday after official data confirmed Eurozone industrial output fell sharply during the final quarter, leading analysts to warn the economy is faltering and that the outlook for European Central Bank (ECB) interest rate policy has deteriorated. 

Eurozone industrial production fell by -1.7% in November, more than reversing a downwardly-revised 0.1% gain from October, when markets had looked for growth of 0.3%. The Republic of Ireland led the way with output down by a staggering -7.5%.

Portugal, Germany, Lithuania, France and Italy also saw steep falls. In Portugal output fell by -2.5% and in Germany and Lithuania it was down -1.9%. French industrial output dropped by -1.3% while in Italy, it fell -2.6%.

The data is the final installment in a dire series of industrial figures that are seen weighing on the Eurozone economic growth for the final quarter. Eurozone GDP grew by only 0.2% in the third-quarter and now economists are speculating it could have weakened even further into year-end.

"The numbers bode ill for GDP in Q4. Even if the fall in industrial production in November was fully reversed in December, output would have fallen by 0.4% in Q4 relative to Q3," says Andrew Kenningham, chief European economist at Capital Economics

Kenningham says that "for now" he and the Capital Economics team think the Eurozone economy eked out some form of growth for the quarter, but the outlook is finely balanced and the actual outcome will depend heavily on whether there is any bounce-back in December. 

November was a month where business confidence and investor sentiment was dented badly by fears over an escalation in the trade war between the U.S. and China, which were tempered at the end of that month by an agreement to defer more and higher tariffs until March 01 to give negotiators time to agree a deal that ends the dispute.

"We will not tire of reiterating how important Chinese demand has become to Germany. The slowdown in China alone can explain c 20bp less GDP growth in Germany compared to 2017. An additional 10bp are part of our base case. The negative spillover can grow quickly," warns Evelyn Hermann, an economist at Bank of America Merrill Lynch. 

President Donald Trump is threatening to raise the 10% tariff charged on $250 billion of China's annual exports to the U.S., and target its remaining $267 billion of exports, if a deal ending its "unfair trade practices" is not reached. 

Despite the 90-day detente, an industrial rebound in December might be unlikely because Chinese trade data released Monday showed the imports into the world's second largest economy falling -4.4% in December and exports also declining. So output from China's factories may also have been hurt by Trump's trade war at year-end.

Above: Euro-to-Dollar rate shown at daily intervals.

The Euro was quoted -0.01% lower at 1.1464 against a strong U.S. Dollar on Monday amd os dpwm -0.05% for 2019, while the Euro-to-Pound rate was -0.12% lower at 0.8910 and has declined -0.91% this year.

The single currency has followed China's Renmimbi and traded according to the whims of the U.S. Dollar of late, with responses to economic data generally short-lived. This could be because the market has already priced out any hope of an interest rate rise being announced at any point in 2019.

"We sell EUR/AUD at 1.6070, targeting 1.5280," says Kamal Sharma, a strategist at Bank of America. "Broader risk metrics are signaling a tactical buy. AUD is the obvious beneficiary of improved risk sentiment. EUR may struggle against backdrop of soft EZ (Euro Zone) data."

Above: Euro-to-Pound rate shown at daily intervals.

"Fears of a technical recession in large Eurozone economies are mounting as industrial production in November provided a harsh reality-check for economists. The third quarter slowdown to just 0.2% GDP growth was expected to be followed by a bounce back in Q4, but the evidence is mounting that this is unlikely," says Bert Colijn, an economist at ING Group

The weak industrial figures seen in Germany and Italy in November had already left both economies teetering on the edge of a so-called technical recession, which is defined as two consecutive quarters of economic contraction. 

This, and the deteriorating outlook for the economy in the New Year could have significant implications for the European Central Bank policy communication on January 24 and for its policy outlook this year more generally. 

"If GDP growth does not improve from last quarter’s 0.2%, it will become difficult for the ECB to maintain its forecast of 1.7% growth for the year. Doubts about the first rate hike will therefore only grow with an economy that does not seem to be able to catch a break and downside risks continuing to feature prominently in the global economy," warns Colijn.

A faltering economy will make it even less likely that growth is sufficient to enable inflation to make a sustainable return to its target of "close to but below 2%" this year, casting doubt over whether the ECB will be able to raise its interest rate once "through the summer of 2019" like it has suggested it will.

ING's Colijn is not alone in warning about the impact that recent data could have on the ECB policy outlook as Kenningham at Capital Economics has written extensively on the subject. Capital Economics is now forecasting the Eurozone economy will grow by just 1% in 2019 and at an even slower pace next year.

Core inflation, which ignores commodity items like fuel so is thought to be a more reliable measure of price pressures, is projected to remain around 1%. This all but puts the ECB's 2019 interest rate guidance into the bin.

As a result Kenningham is also forecasting that the ECB will not get to hike its interest rate this year, or in the current economic cycle at all, which is significant for the Euro currency's outlook because its appeal to investors has been hinged on the idea the ECB will normalise its interest rate structure this year.

"With underlying inflation a long way short of its close-to-2% target, the ECB is unlikely to raise policy rates at all this year or next, and will thus miss out entirely on the global tightening cycle. This would leave the ECB looking similar to the Bank of Japan," Kenningham writes, in a recent note to clients.


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