The latest PMI business surveys from the euro area will be released early on Monday, starting with the French numbers at 08:15 GMT. Inflation has fired up and the jobs market is healing quickly, pushing the European Central Bank to signal that rate increases are coming. The timing remains uncertain though, so the upcoming data could be crucial in shaping market expectations and thus driving the euro.
Heating up
There’s a raging debate in market circles around the ECB’s next move. Even though there’s still a long way to go, the Eurozone economy has improved dramatically, with the unemployment rate reaching its lowest level since 2007 and inflation rising at the fastest pace since the euro came into effect.
And while economic growth hasn’t been impressive, the good news is that fiscal spending will continue to trickle in throughout the year, as the European recovery fund money is still being distributed to member states. This is in contrast to America, where all the government spending was frontloaded last year and the fiscal taps are now closing.
As such, the ECB has started to take baby steps towards higher interest rates. At its latest meeting, President Lagarde did not rule out raising rates this year and hinted that asset purchases could be reduced faster than previously signaled. Markets are currently pricing in two rate hikes by December and there’s speculation about ending asset purchases completely by the third quarter.
The missing ingredient for the ECB to turn even more confident is wage growth. A strong acceleration in wages would suggest that ‘organic’ inflationary pressures are starting to fire up, so inflation might persist even after supply chains correct. Hence, the upcoming PMI surveys will be watched closely – are businesses ‘complaining’ they have to pay higher salaries?
PMIs set to improve
With the measures to fight the Omicron wave being lifted in most countries, the PMIs are expected to rise in February, albeit only slightly. The composite index for the entire Eurozone is projected at 52.7, up from 52.3 in January but nothing to write home about. Economists seem to expect the tensions in Ukraine to have kept a lid on business confidence.
The initial reaction in the euro will depend on any surprises in these numbers. Taking a technical look at euro/dollar, a positive surprise could send the pair above the 1.1395 zone, turning the focus towards the 1.1485 region.
On the other hand, a disappointment might see the bears test the 1.1280 level, where a violation could open the door towards 1.1230.
Euro outlook
In the bigger picture, the euro has been entirely at the mercy of risk sentiment lately as markets grapple with the threat of war in Ukraine. This could have tremendous repercussions for the Eurozone as most nations would have to impose sanctions on Russia if it does invade, which could backfire by pushing energy prices higher.
There are other risks too, for example President Macron losing the upcoming presidential election in France to a Eurosceptic or the Italian bond market going berserk now that the ECB is taking away the ‘medicine’.
But the second half of the year could be a different story for the euro. If European wages start to show signs of life and political risks fade away, that could be a recipe for a relief rally, especially if that coincides with ‘peak inflation’ in America and traders dial back their aggressive Fed bets.
It might take a while to get there, but the longer term picture for the euro is starting to improve.
