Caution reigns ahead of the ECB rate announcement and US CPI

European stocks eased back from record highs on Thursday as investors look cautiously ahead to two key risk events – the ECB rate announcement and US CPI inflation data.

Stocks in Europe have been quietly edging higher to fresh record levels over the past four sessions. All eyes are now on the ECB. The central bank is not expected to move on interest rates, and the PEPP is expected to remain at €1.85 trillion.

The latest data from the Eurozone has been mixed. PMIs were encouraging, but retail sales and German ZEW sentiment missed the mark. Inflation reached the ECB's target of 2% but is expected to be only temporarily at this level.

Just a fortnight ago, ECB President Christine Lagarde said it was too early to talk tapering support. The markets will be keen to see signs that the ECB is willing to keep the monetary taps turned on.

The PEPP programme allows for the monthly purchase amount to be adjusted. The ECB frontloaded purchases, increasing to a pace of bond purchases in its March meeting. Given the accelerating vaccine rollout, the easing of lockdown restrictions and the improving outlook, the ECB could adjust the statement's wording to take bond purchases back to pre-March levels. This could be viewed as a step towards tapering.

As ECB President Christine Lagarde starts her press conference, US CPI data will be released. Expectations are for inflation to rise to 4.7% YoY after the 4.2% April print spooked the markets last month. Despite prices rising at the fastest pace in almost 12 years, the Fed came out in their droves to reassure that the spike in inflation is transitory and calm market expectations of a sooner move to taper support. The Fed was united and unwavering in its message, and the market bought it. Yields on the 10-year treasury hit a monthly low.

A stronger-than-forecast print today could tip the taper talk dial to sooner rather than later, which could bring stocks lower. US futures are pointing to a mixed start on the US open, with the tech-heavy Nasdaq set to underperform its peers.

FX – USD rises, GBP hit by Brexit jitters, COVID

The US dollar is edging higher in cautious trading ahead of the US inflation print. Activity in the FX markets has been somewhat subdued all week, with investors not wanting to take on large positions ahead of the key release. CPI is expected to rise 0.4% MoM in May. Another strong print would make it more challenging for the Fed to defend its bearish stance. Bets of an earlier move to taper would almost certainly rise, boosting the US dollar.

The pound is underperforming its major peers after the EU threatened tariffs on the UK as the bitter war of words over the Northern Ireland Brexit protocol continues. Talks between both sides ended without a breakthrough yesterday, making it more likely that the UK will bring it up at the G7.

The other grey cloud hanging over the pound is rising Covid cases. Daily Covid infections continue to creep higher with just one week to go until a decision over Freedom Day will be taken. Given the depressed state of the pound, doubts are rising that it will go ahead.

Oil slips as fuel demand disappoints

Oil prices are edging lower as the start of the US summer driving season has failed to live up to the hype. EIA stockpile data in the US, the world's largest oil consumer, revealed a softer-than-expected fuel demand in the US at the start of the key summer period.

Oil stockpiles fell for an 11th straight week, which is an encouraging sign. However, fuel inventories rose sharply owing to weak consumer demand.

The oil market has been hopeful of a strong US driving season to boost demand. So far, the data suggests otherwise. Even so, traffic levels are rising, and the vaccine programme continues at a rapid pace, which bodes well for the outlook.

The uptrend for oil remains intact, but the data has served to rein the bulls in and remind us that the road to recovery isn't linear.

Gold eyes CPI for next move

Gold prices are falling lower for a third straight session after briefly pushing over USD1900 at the start of the week. The precious metal trades around its weekly low as nerves creep in ahead of the ECB rate decision and US CPI data. These key events will shed some light on the pace of the global economic recovery and central bank policymaker's stance towards stimulus.

A stronger-than-forecast rise in CPI could boost bets that the Fed will rein in support sooner, which could be negative for non-yielding gold.

Technically the picture is bearish. Having breached support at USD1880, sellers could look to target USD1856, the 4 June low.