Low inflation in Germany and Spain raise pressure on ECB

EUR/USD trades lower this morning on the back of lower than expected inflation figures from Spain and Germany. Spanish inflation dropped 0.2% y/y in March from +0.1% y/y in February and some of the German regional inflation figures also came out lower this morning, indicating a downside risk to the German CPI data released later today. All in all, today’s low inflation prints supports the case for a further decline in consumer prices to a cycle low of 0.5% y/y in the coming months. This would not be in line with the ECB’s outlook for inflation and Eonia rates has declined indicating market price in a higher probability of some ECB action already in April. Together with the hawkish rhetoric from the Fed and the overweight of speculative long EUR positions (according to the latest IMM data), ECB easing is a risk to our 3M EUR/USD target at 1.42.

The drop in European money market rate also has a negative impact on EUR/DKK which has dropped below 7.4660 this morning after it yesterday was flirting with the 7.4670 levels (the highest level seen since February 2006). So far, the central bank has not felt pressured to intervene to support DKK and the lack of action from Danmarks Nationalbank over the recent period of krone weakening could be a subtle indication that the reaction function of Danmarks Nationalbank has changed under the new governor Lars Rohde. Hence, so far, Rohde has relied on the market to determine the EUR/DKK exchange rate freely and, therefore, presented himself as a less activist central bank governor than his predecessors. One important argument for the absence of intervention is the current strong support the krone is getting from the large external surplus, which puts appreciation pressure on the krone.

At the moment financial markets in Asia and commodity currencies such as AUD, NZD and CAD are supported by a possible policy easing in China. Sentiment improved markedly after a comments from the Chinese Prime Minister, Li Keqiang, who overnight said that “ the country has policies in reserve to deal with economic volatility” and China “can’t ignore “difficulties and risks” from a slowdown. On the surface it suggest that China is moving towards easing bias. However, China has in fact already started easing. Money market rates have declined markedly and in our view at cut in the reserve requirement ration and a cut it the leading interest rates are possible at some stage in May or June. As long as PBoC has easing bias we are unlikely to see any renewed appreciation of CNY.