The Eurozone economy has been showing some signs of improvement over the last three months but is not out of the woods yet. Will the flash PMIs for February point to a further rebound when released on Tuesday at 09:00 GMT? The euro has been consolidating this month as markets re-evaluate how many additional rate hikes are in the pipeline by the Federal Reserve. Can the data put the single currency back on the front foot against the resurgent US dollar?
Recession vs stagnation
Despite the energy crisis, rising interest rates and the ongoing war in Ukraine, the euro area has so far been able to steer itself away from a recession. The bleak PMI numbers registered in the autumn did not translate to negative GDP prints, and so the worst case scenario for the bloc’s economy has been upgraded from a ‘severe’ to a ‘mild’ recession. As things stand, stagnation is the most likely outcome. Not that this is anything to shout about, but it’s a far cry from the even gloomier predictions a few months ago.
The composite PMI rose to 50.3 in January, expanding for the first time since June. The uptick was led by a solid rebound in the services component, though the manufacturing sector continued to contract. With other business surveys also pointing up and the positive boost to exporters from China’s reopening starting to filter through, another modest increase in both the services and manufacturing PMIs is likely in February.
Euro is losing momentum
The question for the euro now is whether the incoming data can continue to significantly surprise to the upside rather than simply improve in line with expectations. The euro has shown a strong correlation to Citigroup’s economic surprise indicator, especially relative to the US. Its recent pullback coincides with a dip in the Eurozone’s index and a jump for the US.
But even if it becomes more difficult for the euro to maintain the same positive momentum as before, the European Central Bank’s hawkish stance is a powerful impediment on the downside. Although headline inflation in the euro area has eased substantially from its peak of 10.6% in October, underlying inflation has continued to climb and this is a big worry for policymakers.
ECB rates seen peaking higher
The combination of a resilient economy and sticky price pressures give the ECB a very strong incentive to keep hiking rates. So, at the very least, the ECB is seen matching the Fed on additional rate increases going forward, if not exceed it. Investors have been steadily upping their bets on how high the ECB will raise the deposit rate, with the latest market pricing implying that rates will peak just under 3.75%. Only a few months ago, it was inconceivable that the ECB would lift rates above 3.0%.
Euro still consolidating
The euro has just slipped below its 50-day moving average (MA) after being unable to advance beyond the $1.0790 mark. Stronger-than-expected PMI figures could help achieve a break above this key level as well as the $1.08 handle to make a dash for the early February peak of $1.1033.
However, if the flash estimates underwhelm and the US PMIs impress in comparison, the euro could test the $1.06 level – the 38.2% Fibonacci of the 2021-2022 downtrend – before potentially dipping towards the January low of $1.0482.
Looking further out to the rest of the year, it’s possible that a recession has merely been delayed rather than averted. But the same also holds true for the US economy and so what traders will be watching very closely for is signs on who will press the pause button first – the ECB or the Fed.