European Inflation Could Force ECB's Hand

After the chaos in the banking sector, the ECB has taken a more cautious approach to rates, but inflation figures from tomorrow might force its hand.

ECB's Fading Position

The ECB was the first of the major central banks to meet in the middle of the collapse of four banks. Credit Suisse was the biggest and most systemically important, right in the ECB's "backyard", and so the shared central bank's debate came down to keeping rates steady to help stabilised banks' balance sheets or raising rates by 50bps as expected to send a message of calm to the markets. The ECB opted for the latter but was careful not to commit to new hikes at the next meeting.

The banking situation seems to be resolving, and concerns are diminishing, and by the time next time the ECB meets, inflation could be back to being the main issue. It's important to remember that CPI hit a new record high before the last policy decision, and since then, ECB members have said that inflation is expected to come down. The stickiness of core inflation has become an issue, with some policymakers suggesting there was too much focus on this underlying measure.

Core Could Be An Issue

The expectation is that slower industrial activity and the concerns around the banking situation would have diminished consumer demand over the last month and help prevent inflation from hitting a new record high in March. However, unions are ramping up pressure to raise wages even in Germany, which could provide further inflation pressure. Germany, after all, was the major contributor to the record inflation recorded last month.

There could be some fluctuation in the markets as each state in Germany reports its flash March CPI figures through the early part of trading today. Monthly German inflation is expected to rise to 0.9% from 0.8% in February. On an annual basis, however, German CPI is expected to come down to 7.5% from the 8.7% reported last time.

The Eurozone will report its flash March CPI figures on Friday, expecting annualised inflation to come down to 7.4% from the prior record high of 8.5%. But core CPI (which excludes food and energy) is expected to tick up to 5.7% from 5.6%, which would be another record high, and could keep the pressure on the ECB to raise rates at the next meeting.

EUR/USD Higher After Open Flag

The EUR/USD pair has been bid since the low of $1.0516, as it completed an open flag formation. If $1.0713 or $1.0631 hold firm in the event of bearish price action, offering a reversal, the pair might break past $1.1033. If $1.0930 gives way first, the chances of returning to the said support will decrease for the foreseeable future.

Source: SpreadX / EURUSD

Key Takeaways

The ECB is taking a more cautious approach to rates, but tomorrow's inflation figures might force its hand. Core inflation has become an issue and is expected to tick up to a new record high of 5.7%. Germany's figures from today might provide clues ahead of the EZ's own release.