Euro Underpinned by Firm German Inflation Readings

Image © Alfred Yaghobzadeh, European Commission Audiovisual Services.

Incoming data points to a tick higher in Eurozone inflation in September, which will keep the European Central Bank (ECB) on the sidelines for the foreseeable future.

Inflation data from the Eurozone's biggest states are coming in, and suggest the Eurozone-wide inflation numbers due later this week will settle higher than was the case in August.

The findings suggest the ECB can retain interest rates at current levels, which should underpin euro exchange rates in the coming weeks.

German state inflation data released on Tuesday shows the all-German inflation print will likely land at 2.3% y/y, ahead of market consensus estimates for 2.2%, and up from August's print of 2.1%.

On Monday, Spain reported inflation of 2.9% y/y, which was up on August's 2.7%. However, France saw annual inflation rise just 1.1%, which is consistent with the economy's ongoing struggles.

Taken together, the market expects Eurozone inflation to rise to 2.2% when reported on Wednesday. Core inflation is expected to move sideways and remain at 2.3% y/y.

These readings are consistent with unchanged interest rates at the ECB, which contrasts with expectations for a more rapid pace of cuts in the UK and U.S. in the coming months.

This means UK and U.S. short-term bond yields can fall towards those of the Eurozone, which should provide a mechanical lift for the euro relative to sterling and the dollar.

"Little to no additional easing from the ECB means that it will be difficult for bond yields to fall meaningfully," says BCA Research in a note released Tuesday. "We continue to see more upside for the euro."

BCA points out that the ECB has successfully delivered the "soft landing" where it brought inflation back to target without breaking the economy.

The other major central banks would struggle to claim a similar success.