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Trading News Report

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EUR/USD: Trading the Euro−Zone CPI Estimate

Tue, Jan 6 2009, 05:57 GMT
by Daily FX Research Team

DailyFX

The euro could face increased selling pressures over the next 24 hours of trading as economists expect the Euro-Zone CPI estimate to fall to an annual rate of 1.8% from 2.1% in November.

Trading the News: Euro-Zone Consumer Price Index Estimate

What’s Expected

Time of release: 01/06/2009 10:00 GMT, 05:00 EST

Primary Pair Impact : EURUSD

Expected: 1.8%

Previous: 2.1%

Effect the Euro-Zone Consumer Price Index Estimate had over EURUSD for the past 3 months

November 2008 Euro-Zone Consumer Price Index Estimate

The inflation outlook for the Euro-Zone fell at its fastest pace in nearly two decades as oil prices slipped below $55 a barrel.
The CPI estimate slipped to an annual rate of 2.1% from 3.2% in October, which is the lowest reading since January, which could allow the European Central Bank to lower borrowing costs further as price pressures alleviate. Meanwhile, the central bank is widely expected to lower the benchmark interest rate by 50bp to 2.75% next week as policymakers expects growth prospects to deteriorate further over the remainder of the year. ECB President Trichet stated that there is a chance for ‘negative growth’ in 2009 as the Euro-Zone heads into a recession, and would allow the central bank to hold a dovish outlook going forward.

October 2008 Euro-Zone Consumer Price Index Estimate

The CPI estimate for the Euro-Zone fell to an annual rate of 3.2% from 3.6% in September, which could lead the European Central Bank to ease policy further as they try to maintain the 2% target for inflation. The central bank increased their efforts in response to the financial crisis as they lowered borrowing costs for the second time in October, and is widely expected to cut the benchmark interest rate again in November as policymakers expect economic growth to weaken further in 2009. President Jean-Claude Trichet noted that another rate cut is ‘possible’ as the outlook for inflation remains weak, but went onto say that the second-round effects remains a ‘concern’ for the central bank. The drastic downturn in the economy paired with easing price pressures allowed the ECB to drop their hawkish rhetoric, and is likely to hold a dovish outlook throughout the next year as the upside risks for inflation diminish.

September 2008 Euro-Zone Consumer Price Index Estimate

EU officials lowered the annual rate of inflation to 3.6% from 3.8% in August on the back of falling commodity prices. The recent drop in crude oil have certainly helped to taper the upside risks for inflation, which could lead the European Central Bank to lower borrowing costs over the coming months as they carry out their one and only mandate to ensure price stability. In addition, the economic slowdown paired with the spillover effects of the financial crisis is likely to weigh on prices going forward, which would only lower the interest rate outlook for the Euro-Zone. Despite expectations for an ECB rate cut, policymakers may continue to hold the benchmark interest rate steady at 4.25% during the October policy meeting as inflation remains well above the 2% target.

How To Trade This Event Risk

The euro could face increased selling pressures over the next 24 hours of trading as economists expect the Euro-Zone CPI estimate to fall to an annual rate of 1.8% from 2.1% in November. Falling commodity prices have certainly helped to mitigate the upside risks for inflation, and price pressures are likely to remain subdued over the near-term as crude oil remains below $50 a barrel. As a result, producer prices fell at its fastest pace in 22 years, which lowered the annual rate to 6.3% from 7.9% in September, while consumer prices slipped to 2.1% from 3.2% to record its biggest drop since 1991. Easing price pressures allowed the European Central Bank to lower borrowing costs throughout the second half of 2008, and widely expected to ease policy further over the coming months as policymakers maintain their one and only mandate to ensure price stability. Meanwhile, Credit Suisse overnight index swaps are showing that market participants expect the ECB to lower the benchmark interest rate by at least 150bp over the next 12 months, which continues to reflect a bearish outlook for the euro going forward. Nevertheless, the hawkish rhetoric held by ECB President Trichet raised arguments that the central bank may hold rates steady at this month’s policy meeting, but could be forced to lower borrowing costs throughout the first half of 2009 in order to meet the 2% target for inflation. Moreover, Bundesbank President Axel Weber stated that inflation expectations are well anchored to ride out the drastic fall in prices, and went onto say that the Euro-Zone is facing a period of disinflation rather than deflation. However, comments by ECB Vice-President Lucas Papademos suggests that deflation is becoming a major concern for policymakers as he stated that the central bank is willing to do ‘what is necessary’ to carryout their mandate to ensure price stability.

Despite expectations for weaker prices, comments from ECB officials suggests that the central bank will hold a neutral outlook amid the risk arising from lower prices, and a higher-than-expected CPI reading could stoke a rally in the euro. Therefore, as market participants expect price pressures to alleviate further, a headline reading above 1.8% would set the stage for a long EURUSD trade. With our expectations at hand, we will look for a green, five-minute candle following the release to generate an entry on two lots of the euro-dollar. We will place our initial stop at the nearby swing low (or reasonable distance), and this level of risk will determine the target for the first lot. Our second target will be based purely on discretion, and in order to preserve our profits, we will move the stop on the second lot to breakeven once the first trade reaches its target.

On the other hand, as the risks for deflation intensify, another drop in consumer prices would favor a bearish outlook for the euro as the ECB maintains a 2% target for inflation. As a result, a CPI reading below 1.8% would favor a short EURUSD trade, and we will follow the same strategy as the long trade mentioned above, just in reverse.

Published on  Tue, Jan 6 2009, 06:04 GMT