We expect euro inflation to decline to a new cycle-low of 0.3% y/y in August

Market movers

• Market focus will continue to be on the developments in Ukraine.

• We expect euro inflation to decline to a new cycle-low of 0.3% y/y in August. The decline should follow due to lower energy price inflation, whereas core inflation is expected to remain stable at 0.8% and food price inflation should be less negative. The persistent low inflation in the euro area has resulted in a considerable decline in market-based inflation expectations during August and another decline in actual inflation could result in new downward movements in inflation expectations. However, we ‘only’ expect a very dovish stance from the ECB together with an announcement of further details about purchases of Asset Backed Securities, 29 August 2014.

• In the US focus is also on inflation as the release of the PCE figures will provide us with more information about when inflation will reach the 2% Fed target. Core and headline inflation are expected to come out at 1.5% y/y and 1.7% y/y, respectively. An increase in food prices is the main reason for the higher headline PCE, while lower energy prices are pulling in the opposite direction. In the US personal spending and Chicago PMI will also be released today.

Selected market news

With a renewed increase in tension between Ukraine and Russia geopolitical risks are back on the agenda, albeit the impact on US and Asian stock markets has not been dramatic. With increasing expectation of further easing from ECB as soon as next week, we continue to see substantial downward pressure on interest rates. Yesterday’s Eonia fixing was -0.004% - the first ever negative Eonia fixing. The 10-year German Bund yields also dropped to a new all-time low of just 0.88%. However, with renewed risk aversion in the market, the peripheral spreads widened yesterday.

In eastern Ukraine there are increasing signs of a de-facto low-scale Russian invasion. However, there have been no major movements overnight and at the moment it does not look like the purpose of opening a new front on the southern Ukrainian coast is to create a corridor, which would be a major game changer. The main purpose of the increased intervention still appears to be to freeze the situation on the battlefield and force Ukraine to the negotiating table. However, with more signs of Russian intervention, there is increasing risk of another round of trade sanctions.

Japan’s July data, released overnight, were weaker than expected, 29 August 2014. Overall the data suggest that the recovery in the wake of the consumption tax hike is weak but that Japan will return to positive growth in Q3 after the sharp contraction in Q2. We think the recent weak data will force Bank of Japan to soften its statement in connection with next week’s monetary meeting but any new easing measures are unlikely until late October.