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Euro to Resume Drop as German Investor Confidence, EZ Inflation Falter

Euro to Resume Drop as German Investor Confidence, EZ Inflation Falter

2010-05-18 04:34:00
Ilya Spivak, Sr. Currency Strategist
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Key Overnight Developments

• NZ Producer Prices Surge, Boosting Rate Hike Outlook
• Japanese Service Demand Slumps Most in Over a Year


Critical Levels

 euroopen051820101

The Euro and the British Pound tracked lower in overnight trade, down 0.5 and 0.3 percent respectively against the US Dollar. We remain short EURUSD at 1.4881.

Asia Session Highlights

05182010 2

New Zealand Producer Prices grew 1.8 percent in the first quarter from the three months ending December 2009, the largest increase in over a year. A pickup here hints that consumer prices may follow suit in the months ahead as higher wholesale costs are passed down into the final price tag, helping to nudge the central bank toward raising interest rates. A Credit Suisse gauge of the markets’ priced-in policy expectations shows traders see a 70 percent possibility of a 25bps rate hike in June and 183bps in tightening over the next 12 months.

Japan’s Tertiary Index of service demand fell 3 percent from the previous month in March, doubling the 1.5 percent decline predicted by economists ahead of the release and amounting to the largest drop in a year. Retail spending led the metric lower, down 1.14 percent from February. The outcome did not prove market-moving however after last week’s more timely Eco Watchers survey saw merchant sentiment rise to 49.9 – highest in nearly three years – with gains in the outlook for employment over the next 2-3 months leading the way.

Euro Session: What to Expect

euroopen051820103

UK Consumer Price Index
figures are expected to show the core inflation rate – a metric that excludes volatile items such as fuel and food prices – slowed to 2.9 percent in the year to April, down from the 3 percent recorded in the previous month. On balance, the outcome may not prove market-moving considering its limited implications for near-term monetary policy. Indeed, a print in line with expectations falls well within the narrow range of values recorded over recent months while the Bank of England remains hamstrung by a still-uncertain fiscal policy landscape. Indeed, BOE Governor Mervyn King and company stressed the need to rein in public finances in their quarterly inflation report but will not know the specifics about the new government’s plans to do that until it unveils its emergency budget in June.

Turning to the continent, Germany’s ZEW Survey of investor confidence is expected to see the closely-watched Economic Sentiment gauge return a reading of 47 in May, down from 53 in the previous month and amounting to the biggest monthly drop since October 2008. The outcome seems hardly surprising given the markets’ preoccupation with the fallout from the EU sovereign debt crisis, a problem that has now reached far beyond its origins on Europe’s southern periphery and is increasingly seen as a threat with worldwide implications. Indeed, bailing out high-deficit countries would imply taking on substantially more debt for those countries (like Germany) that end up putting up the cash for the rescue; financing this debt will drive up borrowing costs, slowing economic growth. Taken together, the Euro Zone is the world’s second largest economy and Germany is undeniably its strongest performer, so a marked downturn there bodes ill for the global recovery at large.

Separately, Euro Zone Consumer Price Index figures are set to put the core annual inflation rate at 0.8 percent in April, the lowest reading on record since the introduction of the single currency. The outcome may bode ill for the single currency if traders take lackluster price growth as giving the European Central Bank more leeway to expand the bond-buying program announced last week, hinting policymakers could succumb to the temptation to inflate their way out of the region’s fiscal troubles.


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