Euro Higher As Traders Trim ECB Rate Cut Expectations, German CPI on Tap (Euro Open)

Key Overnight Developments

• Westpac Said Australia to See First Recession Since 1991
• Australian Consumer Prices Fell Most in Since 1997 in Q3


Critical Levels



The Euro moved higher in overnight trading, retaking the 1.32 level to test as high as 1.3264. The British Pound extended gains against the US dollar, testing above yesterday’s high en route to challenge the 1.43 mark.


Asia Session Highlights



Australia’s Westpac Leading Index fell -2.2% in the year to November, the first negative reading for the annualized rate in over 7 years. The metric is a composite of leading economic indicators designed to forecast the economy’s trajectory in the coming six months, with today’s result suggesting Australia will indeed slip into the first recession since 1991 this year. Although aggressive monetary and fiscal stimulus (as well as lower oil prices) helped business confidence rebound in December, traders may see the effects of these policies losing steam in the months ahead as rising unemployment threatens to weigh on disposable incomes and prompt pre-emptive saving in preparation for the leaner period ahead. Indeed, Westpac Consumer Confidence slipped -2.2% in January, the first decline in three months. Westpac’s chief economist Bill Evans noted that, “There seems little doubt that the central bank will decide to further reduce the overnight cash rate.” The markets seem to generally agree: traders have consistently bid up expectations of RBA interest cuts since the beginning of January and now price in 175 basis points in further easing in the next 12 months.

Easing inflationary pressure gives the central bank ample room to loosen policy: the Consumer Price Index fell -0.3% through the fourth quarter, the most since the three months through September 1997, to put the annualized inflation rate at a yearly low of 3.7%. The pace of price growth has slowed 26% since peaking with commodity prices in the third quarter. Former RBA chief Bernie Fraser believes that the bank is in a position to cut rates to below 2.0%. Beyond monetary measures, an added glimmer of hope for stabilization comes by way of expanding fiscal stimulus, with Treasurer Wayne Swan saying the government was prepared to expand the A$45 billion package already in place if the economy continues to falter.


Euro Session: What to Expect



Germany’s Consumer Price Index headlines the calendar in European hours, with expectations calling for a monthly decline of -0.3% to keep the annualized inflation rate at 1.1% in the year to January, the same reading as in the preceding month. Although easing inflationary pressure coupled with sluggish economic growth would typically amount to a sure recipe for interest rate cuts, the market looks to be pricing in a shift to neutral for the European Central Bank. Overnight index swaps are leaning towards no change in borrowing costs in February and just 25 basis points in easing over the next 12 months. Producer Prices slipped significantly in December, opening the door for a downside surprise on today’s release: falling PPI telegraphs forthcoming declines in consumer inflation as firms pass on lower production costs via cheaper finished products. If the PPI release does prove indicative, traders may see significant selling pressure weighing on the Euro as traders re-price rate cut expectations.

The KOF Swiss Leading Indicator rounds out significant event risk, with forecasts expecting the metric to drop to -0.50 in January, the worst reading on record and the lowest in 13 years. The KOF is a composite of six leading indicators and is designed to forecast the trajectory of the economy for the next six to nine months.


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