Assessing EUR's Approach: Inflation Test and ECB Hawkish Stance

EUR: Gearing up for the inflation test

We aren't surprised to hear the ECB hawks step in with some strong messaging in support of more tightening as the September policy meeting draws closer. Market pricing for the September meeting is probably what has been bothering the hawkish fringes of the Governing Council. Markets have been quite reluctant to fully price in one last ECB hike, and the implied probability of a September move has been stuck below 50%.

Governing Council member Robert Holzmann directly pointed out a high chance of raising rates again, but market pricing has not moved significantly. President Christine Lagarde herself held a generally hawkish tone at her Jackson Hole speech last week and seemed to put little emphasis on the mounting evidence that the eurozone’s economy is rapidly slowing, and there is a need to stick with data dependency. It is clear now that markets are – that is admittedly not too common – fully embracing the data-dependent approach of the ECB policymakers, and are awaiting this week’s inflation figures to make their final call on the September hike. It’s important to set a timeline for this week’s inflation releases: German figures are out tomorrow morning (along with Spain’s), while Thursday sees the release of French, Italian, and then eurozone-wide figures.

Consensus expectations are for a slowdown from 5.5% to 5.3% in core CPI inflation, while our economists forecast 5.4%. That should, on the margin, be enough to trigger one last 25bp rate hike by the ECB in September, and we see upside risks for the euro in the near term. A return and stabilisation above 1.0950 and even retesting 1.10 is possible should inflation prove resilient, but much will also depend on US payroll numbers not exceeding expectations.