EU/US Inflation Critical for EURUSD

Inflation figures from the world's two largest economies will provide an important test of EU and US easing programmes and whether the euro can reach new highs against the US dollar.

Running for the Clouds

The euro has risen against the US dollar since the start of August, when US markets briefly became more pessimistic about the American economy possibly slowing down. Europe's economy was already expected to grow slowly, so the euro maintained its position while investors sold the dollar in anticipation of significant US interest rate cuts by the Federal Reserve. Currently, the ECB is expected to cut rates twice this year (at every other meeting), while the Fed is expected to cut rates four times (at every meeting with a "double cut" in October).

This view favouring more stimulus in the US is based on an assumption that inflation will continue falling in both economies. US and eurozone consumer price data scheduled for release on Friday will test this theory. An unexpected decline in inflation across Europe or a rise in prices for American consumers could halt the euro's recent gains against the US dollar.

Reading Into the Data

The market is pricing respective currencies based on the view that Europe's economy is essentially stagnant, meaning rate cuts would have less impact on inflation. Meanwhile, the US economy is expected to slow and help reduce inflation in the second half of the year. The Federal Reserve's GDPNow model predicts third quarter US growth of around 2% annually compared to a forecast of just 0.7% annual growth for the eurozone. This is seen as reducing the gap in interest rates, largely favouring the euro over the dollar - unless the incoming data differs from expectations.

Eurozone annual inflation is projected to ease to 2.2%, down from 2.6% previously. A sharp slowdown in eurozone wage growth in the second quarter is expected to aid the decline in price pressures. However, core inflation is still seen relatively high at around 2.8%, only marginally below July's 2.9%. In the US, annual PCE is forecast to remain stable at 2.6%, but markets will focus on the core rate, which is projected to stay unchanged at 0.2% monthly. An unchanged or lower outturn would signal the September US rate cut remains on track. Unexpectedly higher July US inflation could cause concern and the Fed may hold rates steady for now.​

EURUSD Upside Under Threat

The EURUSD currency pair has encountered firm resistance at the 1.12 level, retreating near its prevailing upwards-trending channel. This raises the possibility of a slowdown towards the 1.10 round support, while a bounce within the 1.1070-80 range could spur the pair towards its recent high, ultimately opening the door to 1.13.​

Source: SpreadEx / EURUSD

Key Takeaways

Inflation figures from the eurozone and the US will be closely watched this week. Market expectations are for inflation to continue falling in both economies, favouring further easing from the respective central banks. Consumer price data on Friday will test whether inflation is cooling as anticipated, with any surprises that could impact currency markets by changing expectations around the degree of monetary easing. Forecasts suggest the US economy will slow more than the eurozone in the second half of the year, keeping interest rate differentials supportive of the euro, barring surprises in the upcoming inflation readings.​