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Can This Week’s Inflation Report Steer the ECB Away from Another Rate Hike?

We are getting closer to the end of June, and it is time for another euro area inflation report (Friday, 09:00 GMT). Despite the recent moderation in inflationary pressures, CPI releases continue to gravely affect market movements. The euro has been having a mixed month but a strong dataset this week could potentially help it recover some of its recent losses against the pound.

Where are we now?

The European Central Bank has been on a monetary policy restrictive path for the past 11 months, raising rates at every single meeting with the last rate move announced at the June 15 gathering. Lagarde was quite clear at the last press conference that the ECB is determined to continue hiking, unabated by the recent inflation figures and the weaker survey data.

The overwhelming majority of ECB members is treating the July rate hike as a given. Particularly as core inflation remains elevated, employment continues to tighten to record levels and the neighboring central bank, the Bank of England, has decided to ramp up its tightening strategy. The focus has turned to September, a slightly premature reaction considering there are three months left to that meeting.

However, the market is extremely interested in comments regarding the inflation outlook in the second half of 2023. The annual ECB forum on Central Banking is currently taking place at Sintra, Portugal, with the entire ECB executive council, including President Lagarde, expected to make an appearance, and most likely offer their insight on the inflation outlook.

More immediately, the repeated weak prints of the various business surveys, especially the recent German PMI figures and the German IFO survey, ought to have raised some eyebrows at the Bundesbank corridors and energized the ECB doves. Consequently, we expect these doves to highlight the need for restraint. Their attempt to affect the July meeting outcome appears to be doomed unless inflation this week produces a major downside surprise.

June’s CPI will be the key release of the week

The preliminary numbers from Germany are expected on Thursday with the euro area aggregate scheduled to be released a day later. The market is looking for a small uptick in year-on-year German headline inflation, but the euro area headline figure is seen dropping to 5.6% YoY, the lowest print since March 2022. More interestingly, the euro area core subindex is forecast to accelerate to 5.5% YoY. Economists have long argued against the core CPI’s perceived ability to predict the future headline figures, but nevertheless it remains at high levels, raising the risk of inflation becoming entrenched in wage agreements and more generally in the public’s perception.

Should these forecasts be confirmed, the market reaction will probably be modest. More interestingly, a weaker set of results will probably not unsettle the market much, but it will definitely raise questions regarding the September meeting’s outcome. If there is an acute market reaction, it will probably be met with skepticism as the ECB will get another two CPI reports until September, and hence could check if inflation is indeed in a downward spiral. On the flip side, a strong set of data is unlikely to dramatically change ECB expectations, but it is bound to affect the euro, especially against the pound.

Euro suffering against the pound

This pair has been drawing much attention as the pound has recently shown unexpected strength even though the BoE is severely behind the curve in terms of rate hikes. Their recent 50 bps rate move decision could further support the pound, provided they stay on course and avoid a return to the mentality that led to inflation remaining north of 8% for 14 consecutive months.

Technically, the picture is not overly supportive of the pound. The recent sell-off failed to test the key 0.8504 level and the pair is now hovering around the December 2022 lows. Pound bulls could be taking a breather after a good run, but they need to be on their toes as the momentum indicators are flashing red. The stochastic oscillator has broken above its oversold area, sending a strong bullish message. Should the inflation data support the more hawkish outlook for the ECB, we could see the euro/pound pair going higher towards the key 0.8670-08720 area.

On the flip side, weak inflation figures coupled with lingering growth outlook concerns could provide a much-needed boost to the new euro/pound in recording a new 2023 low. If the February 24, 2012 high at 0.8504 is successfully broken, euro bears could then set their eyes lower and towards the 0.8400 area.

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