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Euro Zone Inflation to Hit Record Low - Will ECB Cut Rates in February? (Euro Open)

Friday, 30 January 2009 04:54:14 GMT  |  Ilya Spivak, Currency Analyst

The Euro Zone Consumer Price Index is set to show inflation fell to 1.4% in the year to January, the slowest pace since the adoption of the single currency. The priced-in probability of a 25 basis point cut in February is now 14.8% higher than two days ago. The Euro lost as much as -0.6% against the US Dollar in overnight trading, testing below the 1.29 level.

Key Overnight Developments

• Japan’s Unemployment Rises, Household Spending Falls as Recession Deepens
• UK Consumer Confidence Falls to Lowest in 6 Months, Says GfK
• Australia’s Conference Board Leading Index Slumped for Third Straight Month in November


Critical Levels



The Euro lost as much as -0.6% in overnight trading, testing below the 1.29 level. The British Pound slipped -0.8%, returning to familiar territory near the 1.42 mark. Technical positioning suggests the US Dollar is ready to resume its advance against the major currencies having corrected lower for much of the past week.


Asia Session Highlights



Japan’s labor market continued to deteriorate in December, taking the Jobless Rate to a 3-year high of 4.4% and the ratio of available jobs to seeking applicants to a meager 0.72, the lowest since November 2003. Shrinking global demand has pushed companies to cut back production capacity and boosted unemployment, weighing on consumer spending and depressing overall economic growth. Indeed, the Nomura/JMMA Manufacturing Purchasing Manager Index showed sentiment fell to a new record low at 29.6 in January on lack of demand for Japanese cars and electronics while Household Spending shrank -4.6% in the year to December, the largest drop in over 2 years. Looking ahead, things continue to look bleak for the world’s second largest economy: the International Monetary Fund said this week that global economic growth will come to a “virtual standstill” in 2009 to yield just 0.5%, the lowest yet in the postwar period. Such a scenario is likely to substantially prolong the economic downturn for heavily export-oriented countries (Japan included). Indeed, the monthly report from the Bank of Japan asserted that “economic conditions are likely to continue deteriorating for the time being.” Although sluggish economic activity has brought the Consumer Price Index to a 14-month low of 0.4%, the BOJ is unlikely to capitalize on the slowing pace of inflation with added monetary easing. In fact, policymakers are running short on options with benchmark interest rates already at just 0.10%. Governor Maasaki Shirakawa and company have introduced aggressive, new measures to stimulate lending and investment. Should these fail, the last ditch effort to reboot the economy may intervention in the forex market to drive down the value of the Yen, making Japanese exports cheaper and thereby more attractive.

The GfK Consumer Confidence Survey printed at -37 in January, the lowest in 6 months. The sub-category measuring future savings intentions saw the most pronounced decline, dropping to -18 from -8 in December, the worst reading since the survey was introduced in 1996. The implications are quite clear: the dire economic environment has boosted unemployment, trimmed disposable incomes, and left UK households with little left over to build savings. Eroding savings signal that the UK recession may intensify in the coming months: as more people lose their jobs, savings are substituted for salaries; without being replenished by new income, these savings will be depleted, accelerating the drop in consumption and deepening the contraction in economic growth. Although the markets are pricing in just 50 basis points in additional easing from the Bank of England, Governor Mervyn King saw has explicitly warned of a “marked” contraction in the first half of 2009 and suggested a move to quantitative easing in the coming weeks. King specifically mentioned the central bank may buy corporate bonds and commercial paper to boost access to lending. The government has also ramped up fiscal measures, guaranteeing 21.3 billion pounds worth of loans to companies and spending 500 million pounds to encourage hiring.

Australia’s Conference Board Leading Index slumped 1% in November, the third consecutive month of losses. Building approvals, stock prices, agricultural exports, and interest rates all declined. The metric consists of eight total leading indicators intended to forecast the path of the overall economy over the forthcoming three to six months.


Euro Session: What to Expect



The initial estimate of the Euro Zone Consumer Price Index is set to show inflation fell to 1.4% in the year to January, the slowest pace since the adoption of the single currency. The reading is dropping increasingly farther below the key 2% reference level that the European Central Bank uses to define “price stability”, threatening to make deflation a serious concern for the regional bloc if left unchecked. The danger here is quite significant: if consumers and businesses expect prices to fall in the future (i.e. inflation turns negative), they will perpetually put off purchases waiting to get the best possible deal. This puts the breaks on spending and investment, halting economic growth. ECB President Jean-Claude Trichet has been sending mixed signals about the likely direction of monetary policy in the coming months. First, Trichet cautioned that very low rates “have some inconveniences" and noted a need to see “new information” (alluding to waiting to act until the March meeting). The very next day, CNN reported that Trichet has not excluded taking rates below 2%. Looking at overnight index swaps, the priced-in probability of a 25 basis point cut in February is now 14.8% higher than two days ago. A separate report is set to show that the Euro Zone’s Unemployment Rate ticked to 7.9% in December, the highest in 2 years.

In the UK, the effects of the housing slump and the global credit squeeze are set to be on full display as Mortgage Approvals grow by just 26k, the smallest in at least 15 years, while Net Consumer Credit shrinks to 0.7 billion points from 0.8 billion in the preceding month.


To contact Ilya regarding this or other articles he has authored, please email him at ispivak at dailyfx dot com.

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