European inflation data will be closely watched

Euro Research Report

ECB disappoints market with no new stimulus

European inflation data will be closely watched

UK data begins to falter

Sterling Euro (GBPEUR) FX Technical Analysis

We saw a lot of volatility in the market this month and this time it wasn’t just one way traffic higher for the Pound to the Euro. The pound fell by 3.5% against the Euro over the course of two weeks after the European Central Bank disappointed the market by announcing no new stimulus measures, despite inflation weakening to a five-year low and Germany, the Eurozone’s largest economy cutting its growth forecast for 2014 from 1.8 % to 1.2%. Instead the ECB signalled it will wait to see if stimulus measures undertaken in recent months will be enough to lift the Eurozone’s ailing economy. The ECB has offered banks four-year loans at ultra-cheap rates and begun buying ultra-safe covered bonds, which also includes asset-backed securities. These measures are intended to have a sizeable impact on the balance sheet and entice banks to lend, which in turn should help to contribute to increasing inflation rates closer to the ECB target rate of 2%. These measures should be welcomed with open arms as lending within the Eurozone to households and companies has contracted for the 29th month in a row.

Tomorrows flash inflation reading for the Eurozone now has increased significance. The market is predicting a slightly better figure of 0.4% than the previous reading at .3%. It will be too early to tell whether the covered bond programme has worked as these measures take time to gain traction but perhaps the ambiguity the ECB has conveyed around the issue of quantitative easing has done the their job for them. No one seems to know for sure whether they will launch QE or not, which has kept pressure on the Euro (weaker currency helps exporters and promotes inflation). Unfortunately Data released over the month would suggest otherwise as confidence deteriorates, German investor sentiment hit a 22 month low and Germany factory orders slumped the most since 2009. Benign inflation is not just confined to the borders of the Eurozone, there are signs of slowdown globally which has been reflected in the falling prices of commodities. This slowdown is now starting to affect the UK recovery, while the economy is still growing we are now seeing tentative signs of a slowdown. Inflation in the UK underwhelmed this month at 1.2% vs last month reading of 1.5% which is the lowest rate for five years, this has been exacerbated by the recent falls in oil prices and a stronger pound which has lowered the cost of imports.

The Service sector PMI (forward looking indicator) which makes up around 70% of UK GDP, came in at a three month low in September and the private sector dropped from 59.7 to 58.1, its lowest level in six months suggesting that Q4 GDP may be sluggish and that the UK recovery appears to be losing some momentum. This drop in inflation and slowdown in GDP eases any pressure on the Bank of England to raise interest rates in the medium term and most analysts expect the first hike to be late in 2015.

Whilst it appears that the UK economy might be slowing it still has a much strong footing than the Eurozone and the MPC is surely near the beginning of its tightening cycle. The divergence between the two central banks which exists which should still support the GBP higher in the short term whilst the Euro will struggle to make gains as the ECB continues to add stimulus.

For EUR Buyers

Currently trading close to the recent highs and 1.2700 needs to be cleared in order for higher prices to confidently predicted. As we have bounced fairly aggressively from the mid-month dip to 1.2430 I would suggest reducing exposures close to here and certainly if 1.2850 is seen again. A break above 1.2874 would open up 1.3000 before the year end.

For EUR Sellers

It is still looking a little murky out there for euro sellers. Once more I think that if you haven't covered your requirements already you may as well leave protection around 1.2900. If we do see any dips towards 1.2500 take profit orders should be left around that level.