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EUR/USD Extends Gains after Signs of Economic Rebound Leave Forecasters in a Tight Spot  

 © Grecaud Paul, Adobe Stock

- EUR up on M&A speculation, Chinese and Euro economic news.

- Q1 industrial fall shallower than thought, sector may be turning. 

- Leaves forecasters in awkward spot pending further information.

The Euro advanced against rivals Friday when official data appeared to suggest the first-quarter industrial downturn may have been shallower than markets had previously thought and after Chinese economic figures surprised on the upside.

Europe's single currency received a sharp boost overnight, which analysts say was the result of merger and acquisitions activity, with some suggesting the move could be connected to MUFG's agreement to buy the aviation financing business of DZ Bank that was announced on March 01. 

"USD is generally slightly softer overnight, led by EUR pushing back to the top of the week’s range on reports that  Mitsubishi UFJ would buy the aviation financing business of DZ Bank, valued at around EUR6bn," says Adam Cole of RBC Capital Markets. "Otherwisae, news flow has been very light and as we go to press, China’s March trade figures have still not been released."

People's Bank of China (PBOC) data later showed loan issuance by domestic lenders almost doubling during March, after having fallen sharply in February, while the trade surplus also rebounded from depressed levels too. 

Chinese economic weakness resulting from the so-called trade war with the U.S. was one of the key drivers behind the 2018 collapse of Eurozone factory activity so any signs of a pick-up in the world's second largest economy would always be positive for the Euro. 

That set the Euro on a positive path before the opening of the European session, although the currency has since made further headway against the U.S. Dollar following signs the industrial downturn on the continent may not be as severe as some surveys have been suggesting. 

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

"We’re not at all surprised to see EURUSD trading above 1.1300, and this corroborates our earlier arguments concerning patience when it comes to the right time to sell EURs.  But we’re naturally sceptical of the positive vibe markets have adopted in the wake of the latest Chinese data, and of what the data are really telling us," says Stephen Gallo, European head of FX strategy at BMO Capital Markets.  

Eurozone industrial production fell by -0.2% during February when markets had looked for a much larger -0.5% decline. Furthermore, the estimated 1.4% increase in production from January was revised higher to 1.9%, which means industrial output thus far in 2019 has been substantially higher than markets thought was the case. 

The Eurozone industrial sector has been the key driver behind the economic slowdown that saw GDP growth fall from from 0.4% in the second quarter of 2018, to 0.1% in the third and just 0.2% for the final quarter.

"Most of the core manufacturing sectors registered modest declines, though in all cases, the dips were much smaller than the gains in January," says Claus Vistesen, chief Eurozone economist at Pantheon Macroeconomics. "Across the major economies, production fell slightly in Germany and Spain, while it increased in Italy and France. These data pose a bit of a conundrum for forecasters."

Eurozone growth was just 1.8% in 2018 overall, down from 2.3% the previous year, and some influential forecasters are suggesting the economy could expand by as little as 0.9% in 2019. Commerzbank forecasts Eurozone GDP growth of 0.9% this year. 

Friday's data may have come as a shock to the market because IHS Markit PMI surveys have pointed clearly to a deepening of the recession in the Eurozone manufacturing sector during the first-quarter, although those surveys frequently overestimate the size of upward and downward changes in output.

"Based on just the January and February numbers, industrial production growth is headed for a much stronger Q1 headline than implied by the terrible survey data," says Vistesen. "We fear the worst, but even if we assume a significant setback of about -2.5% month-to-month—in line with the surveys—industrial production would still come in flat quarter-on-quarter for Q1, significantly better than the 1.2% decline in Q4, and much stronger than predicted by the PMIs."

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

The European Central Bank (ECB) said Wednesday the Eurozone economy is likely to have slowed further in the New Year and warned that inflation could fall even more than it already has over the coming months, in part because of the economic slowdown. 

That kind of outlook is why the bank also confirmed it will launch another round of targeted-long-term-refinancing-operations (TLTROs) in September as part of an effort to stimulate demand in the hope of lifting inflation back toward the target of "close to but below 2%". 

"February’s industrial production data suggest that output in the sector performed a little better in Q1 than at the end of last year, but the sector is still struggling. And with global economic growth set to remain weak this year and next, euro-zone industrial production is likely to continue to be sluggish too," says Jack Allen, an economist at Capital Economics

This weak economic pulse is undermining the outlook for Eurozone inflation, which is key to the European Central Bank interest rate outlook. The ECB is targeting inflation that is sustainably "close to but below 2%", but both headline and core measures of inflation have spent much of the time since the 2012 debt crisis well below that level. 

After reaching 2.2% in 2018 amid a steep climb in oil prices, the consumer price index fell from 1.5% to 1.4% in March 2019. Core inflation, which most economists say is a better measure of true price pressures in an economy, fell from 1% to 0.8% that month, its lowest level since March 2017. 

Core inflation has not been above the 1.2% ever since the Eurozone debt crisis, but until the target can be achieved in a sustainable manner, markets will have little chance of seeing a European Central Bank interest rate hike.

"If data stabilises, the ECB will be keen on hiking at the end of this year. But our conviction level is low (and declining) - similar to the ECB's. The alternative, we argued, would be no hike this year, a long extension of forward guidance beyond market pricing and tiering. The debate is shifting from base or risk scenario to the details (what to do?) and sequencing (how quickly to do it?) in the risk scenario," says Ruben Segura-Cayuela, an economist at Bank of America.

 

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