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Weak EU inflation belies ECB policy expectations

US markets ended their recent winning streak after a rise in interest rate expectations pushed up yields and raised the prospect of four US interest rate rises this year. The US 10-year yield took out its previous 2013 peaks to close at its highest level since 2011, while 2-year yields edged closer to the 2.6% level. 

This rise in the US dollar and yields along with reports that North Korea had cancelled a meeting with South Korea over the continuation of military drills with the US that were due to resume today, appears to have prompted this reduction in risk appetite, along with concerns that next month’s nuclear talks with the US in Singapore might also be cancelled in response to this “intentional military provocation”. 

We hear an awful lot from central bankers that inflation isn’t a thing, yet US bond markets appear to be telling us something different. Both the US 10 year and 2-year yields hit their highest levels in years yesterday after US retail sales for April slipped back from some decent March revisions while prices paid in the latest Empire manufacturing survey came in at their highest levels since 2011.

This sort of inflation syncs up with the ISM prices paid components which have shown similarly elevated readings in recent months. All the while oil prices have continued to make fresh new multi-year highs with Brent crude coming within touching distance of $80 a barrel yesterday. The rise in oil prices since last summer is now up near 70%, with the price of everyday items on both sides of the Atlantic getting more expensive, while wage growth remains subdued, though the recent tax cuts may help offset some of that.

In the UK we saw average weekly wages for March rise to their highest levels since 2015, coming in at 2.9%, meaning that on a headline basis earnings are now rising faster than CPI, which is currently at 2.5%.

While central bankers insist that inflation expectations are declining, or in the main subdued, consumer spending does appear to be showing signs of slowing down, even accounting for the nice pop we saw in US retail sales in March.

Today’s EU inflation numbers are expected to paint a similarly benign outlook despite this week’s comments from various ECB officials that the central bank remains on course to curtail its asset purchase program by the end of this year.

While this may well turn out to be true on the ECB’s headline measure for inflation the central bank remains well short of meeting its target. Even German inflation is below the ECB’s measure, expected to come in at 1.6% for April.

Today’s EU CPI number is expected to show a final reading for April of 1.2%, while core CPI is even lower at 0.7%, a three-year low, and only 0.1% above its all-time low of 0.6% which we saw in December 2014.

Coincidentally this was also the low just prior to the ECB starting its controversial asset purchase program in January 2015, so after over three years of low and negative rates, and a €2.3trn increase in the ECB balance sheet, the net gain in EU core inflation has been 0.1%!

When looked at through that particular prism that is astonishing and could be argued in terms of its inflation mandate, a failure. It is less of a failure when assessed against other measures like GDP growth, or what have you, but on that basis can they really afford to consider curtailing their asset purchase program?

EURUSD – the failure to overcome the 1.2000 level as well as the 200-day MA prompted a return the 1.1820 level yesterday. While below 1.2030 the pressure on the downside is expected to remain with the 1.1780 level the next target. A move below targets a move to 1.1710 and the December lows.

GBPUSD – made a marginal new low at 1.3450 before rebounding and as such this remains a key line in the sand. We need to overcome the 1.3620 area to stabilise and argue for a move towards 1.3720. A failure to do so invites further losses towards the 1.3300 area in the medium term.

EURGBP – continues to drift lower after the weeks failure at 0.8845 and the 200-day MA at 0.8880 the risk remains for a move back towards last week’s lows at 0.8740, and below that at 0.8690.

USDJPY – finally cracked the 110.00 area as well as the 200-day MA and trend line resistance at 110.30, suggesting the potential for further gains towards the 111.20 area. We need to hold above the 109.70 area for this to unfold or risk a return to the 108.70 area.

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