Germany CPI Preview: Inflation set to ease further, not necessarily negative for the Euro

The Federal Statistical Office of Germany (Destatis) will release inflation data on Wednesday at 13:00 GMT. The annual German Consumer Price Index (CPI) is expected to rise 3.5% in November, down from the 3.8% increase reported in October. If confirmed, it would be the lowest reading in over two years. The CPI is expected to show a 0.2% decline in November. The Harmonized Index of Consumer Prices (HICP) is forecast to slow from an annual rate of 3.0% in October to 2.7% in November. 

This week in Germany, the focus is not solely on inflation but also on the budget crisis following the Constitutional Court's ruling on the use of off-budget funds. German Economy Minister Robert Habeck will present a supplementary budget.

Inflation figures from Germany have the potential to impact monetary policy expectations from the European Central Bank (ECB) and, consequently, the Euro (EUR). Despite the Eurozone economy contracting by 0.1% in the third quarter, the common currency has been rising against the US Dollar (USD), Pound (GBP), and even the Swiss Franc (CHF) in recent weeks. The evidence of inflation slowing down contributes to a modest improvement in the region's economic outlook. However, a rebound in inflation in Germany could briefly support the Euro, even though it may be seen as negative news for the ECB.

The impact on the Euro and ECB monetary policy expectations will depend on the overall inflation readings from Europe, which will be released starting early on Wednesday, beginning with Spain's figures, followed by regional figures from Germany. Since markets will have already received abundant data before the German national statistics, the impact immediately after the report might be limited. More inflation data is due Thursday, including numbers from France, Italy, and finally, the Eurozone from Eurostat. The latter is expected to show an increase of 2.8% from a year ago (it would be a new cycle low), down from October's 2.9%. The core measure is expected to slow to 3.9%, still well above the ECB's 2% target. These numbers are preliminary figures and are usually not revised.

Walking the last mile

If inflation rebounds, the Euro could benefit, but only briefly. An economic outlook that includes higher interest rates for longer or an ECB pressured to raise rates further, is not optimistic. However, this is not the most likely scenario. If inflation slows more than expected, the Euro could still benefit, despite the natural expectation that lower interest rates would be harmful for the currency. Considering that the economy is stagnant, a favorable inflation outlook, allowing for some monetary easing in the first or second quarter of next year, would be welcomed news.

Even if inflation slows down in the Eurozone and Germany, it will remain above the ECB's 2% target, but will it be considered "too high"? According to the accounts of the last ECB meeting, “it was stressed that there was no room for complacency, as the difficult part of the disinflation process was only starting. Inflation dynamics over the remainder of the year would likely be characterised by various base effects that could be misinterpreted as a reversal in the inflation trend and lead to market volatility, although the inflation uptick would be short-lived and would not change the overall disinflationary outlook. In this context, it was cautioned against declaring victory over inflation at the current stage, when inflation was still more than twice the ECB’s target.”

Hence, it is clear that despite the extent of the inflation slowdown, no victory will be declared. At the same time, economists explain that the December inflation figures will be closely watched. They point out that the base effects that contributed to the decline in annual rates in November will no longer be present. The last mile of the journey to bring inflation back to target could be longer than 1.6 kilometres. 

EUR/USD outlook 

The EUR/USD is moving with a bullish bias and is testing the 1.0950 area. If the Euro consolidates above with a daily close, it would reinforce the upward bias. The next target on the upside is around 1.1100. However, that level is a strong resistance that could trigger a correction if reached over the subsequent sessions.

On the downside, the 1.0880 level is a strong support level, and consolidation below could suggest a deeper downward move, potentially towards 1.0830. This level could attract new buyers. If the pair drops and stays under 1.0770, the outlook could change to neutral.