Core inflation in Europe rebounds, Euro little moved

The annual Eurozone Harmonised Index of Consumer Prices (HICP) accelerated 5.5% in June vs. May’s 6.1% increase, the latest data published by Eurostat showed on Friday. The HICP inflation gauge beat expectations for a 5.6% increase.

The Core HICP inflation rose to 5.4% YoY in June, compared with May’s figure of 5.3%. Markets had forecasted a 5.5% clip.

On a monthly basis, the old continent’s HICP rose 0.3% in June vs. no growth reported in May. The core HICP inflation came in at 0.3% in the reported month, as against the 0.7% expected and 0.2% recorded in May.

Note that the European Central Bank’s (ECB) inflation target is 2%.

The bloc’s HICP figures have a significant impact on the market’s pricing of the ECB rate hikes. Markets are currently pricing an 89% probability of a 25 basis points (bps) ECB rate increase to 3.75% in July.

Key details (via Eurostat)

"Looking at the main components of euro area inflation, food, alcohol & tobacco is expected to have the highest annual rate in June (11.7%, compared with 12.5% in May), followed by non-energy industrial goods (5.5%, compared with 5.8% in May), services (5.4%, compared with 5.0% in May) and energy (-5.6%, compared with -1.8% in May)."

EUR/USD reaction

The shared currency is unfazed by mixed Eurozone inflation data. EUR/USD is trading at 1.0839, down 0.20% on the day, as of writing.

The section below was published at 08:30 GMT as a preview of the European inflation report.

Eurostat is set to release key Eurozone inflation data on Friday, June 30.
Headline annual inflation is seen softening to 5.6%, Core figure is likely to rebound.
Eurozone HICP could have a significant impact on the ECB rates outlook and the Euro.

The Harmonized Index of Consumer Prices (HICP), a measure of inflation, for the Eurozone, will be released on Friday, June 30. The inflation data from the old continent will be closely scrutinized by the European Central Bank (ECB), as “Eurozone inflation has entered a new phase which could linger for some time,” requiring the ECB to keep policy tight and avoid declaring an end to rate hikes, President Christine Lagarde said on day two of the ECB Forum on Central Banking, in Sintra, on Tuesday.

Lagarde emphasized, “we are committed to reaching inflation goal come what may.”

It was Lagarde's first public speech following the weak business PMI and IFO sentiment data, which aggravated concerns about the health of the bloc's economy. Germany’s 2-year and 10-year bond yield curve inverted the most in nearly 31 years on the downbeat economic data. Money markets are pricing around a 4% peak in the ECB deposit rate, predicting the European Central Bank interest rate cuts after they reach their peak.

Analysts at Commerzbank explain, “it is not the economy that is decisive for the ECB’s monetary policy decisions but inflation developments. From Wednesday the first estimates for June from Eurozone countries will be published, with the overall inflation rate for the Eurozone following on Friday. There are concerns that core inflation will remain stubborn. Against this background, it is likely to be premature from the market’s point of view to bet on an imminent pause in the ECB rate cycle at this stage. For that reason, the data might provide support for Euro this week.”

Back in May, inflation in Europe declined sharply to 6.1% vs. April’s 7.0% print, according to the data published by Eurostat. The Core HICP inflation dropped to 5.3% YoY in May as against the expected 5.5% clip, down from the 5.6% figure booked in April. The data suggested that disinflation occurred in every major component in May. However, the fall in the core inflation was partly driven by Germany’s EUR49 travel pass.

What to expect in the next European inflation report?

Therefore, economists are expecting the Core HICP inflation to rebound in June to 5.5% on an annual basis. The European Central Bank closely watches the core figure and hence, the potential increase could hint that the ECB could keep up interest rate hikes coming in the upcoming meetings. The headline annual Eurozone Harmonized Index of Consumer Prices is seen rising 5.6% in June, slowing its pace of increase from May’s 6.1%.

On a monthly basis, the old continent’s HICP is likely to show no growth in June. The core HICP inflation is foreseen at 0.7% in the reported month when compared to 0.2% registered in May.

Its worth noting that in its updated staff projections in the June meeting, the ECB raised core by 0.5% for both 2023 and 2024 to 5.1% and 3% respectively.

Speaking at the 2023 ECB Forum on Central Banking on Wednesday, major central bank bosses, including, Fed Chair Jerome Powell, European Central Bank (ECB) Chief Christine Lagarde, Bank of England Governor (BoE) Governor Andrew Bailey and Bank of Japan (BoJ) Governor Kazuo Ueda, reaffirmed their resolve to fight inflation by keeping up with interest rate increases this year.

Meanwhile, Spain's Consumer Price Index (CPI) rose 1.9% YoY in June, below the 2.0% threshold for the first time since March 2021, preliminary data from the National Statistics Institute (INE) showed on Thursday. The harmonized annual inflation rate arrived at 1.6%, down from May’s 2.9% clip and slightly above the expected 1.5% figure.

Germany’s headline annual HICP surged 6.8% in June, as against the 6.3% previous month’s increase and the 6.7% forecast for June. The Core HICP rose 6.4%, also showed a bigger-than-expected increase annually in the said period. Since the ECB is focused on core inflation, hot German inflation data is expected to put upward pressure on the Eurozone inflation data.

When will the Harmonised Index of Consumer Prices report be released and how could it affect EUR/USD?

Eurozone preliminary HICP is due to be published at 09:00 GMT this Friday. Heading into the highly-anticipated inflation release from Europe, the Euro (EUR) is struggling below the 1.0900 round level against the US Dollar, as mounting recession fears remain a drag on the European currency. Further, the Federal Reserve is viewed as more hawkish than the ECB following Fed Chair Jerome Powell’s speech in Madrid on Thursday. Powell concluded his speech by saying that he “expects a moderate pace of interest rate decisions to continue.”

The hotter-than-expected headline and core HICP inflation data are likely to fuel a rebound in the Euro, as it would squash hopes for an ECB rate hike pause after reaching the peak rate of around 4%. In that case, EUR/USD could resume its uptrend toward the six-week high of 1.1012. Alternatively, should the bloc’s inflation data disappoint market expectations, EUR/USD is set to extend its correction toward the 1.0800 level.

Meanwhile, Dhwani Mehta, Asian Session Lead Analyst at FXStreet, offers a brief technical outlook for the major and explains: “EUR/USD yielded a daily closing below the critical horizontal 50-Daily Moving Average (DMA) at 1.0870 on Thursday. However, the 14-day Relative Strength Index (RSI) has managed to defend the 50 level, lending some support to Euro buyers in the lead-up to the Eurozone inflation report.”

Dhwani also outlines important technical levels to trade the EUR/USD pair: “Any recovery attempt will need validation from the 1.0950 supply zone. The next relevant hurdle for Euro buyers is seen around 1.0970, above which they will look to retest the multi-week top above 1.1000.”

Inflation FAQs

What is inflation?

Inflation measures the rise in the price of a representative basket of goods and services. Headline inflation is usually expressed as a percentage change on a month-on-month (MoM) and year-on-year (YoY) basis. Core inflation excludes more volatile elements such as food and fuel which can fluctuate because of geopolitical and seasonal factors. Core inflation is the figure economists focus on and is the level targeted by central banks, which are mandated to keep inflation at a manageable level, usually around 2%.

What is the Consumer Price Index (CPI)?

The Consumer Price Index (CPI) measures the change in prices of a basket of goods and services over a period of time. It is usually expressed as a percentage change on a month-on-month (MoM) and year-on-year (YoY) basis. Core CPI is the figure targeted by central banks as it excludes volatile food and fuel inputs. When Core CPI rises above 2% it usually results in higher interest rates and vice versa when it falls below 2%. Since higher interest rates are positive for a currency, higher inflation usually results in a stronger currency. The opposite is true when inflation falls.

What is the impact of inflation on foreign exchange?

Although it may seem counter-intuitive, high inflation in a country pushes up the value of its currency and vice versa for lower inflation. This is because the central bank will normally raise interest rates to combat the higher inflation, which attract more global capital inflows from investors looking for a lucrative place to park their money.

How does inflation influence the price of Gold?

Formerly, Gold was the asset investors turned to in times of high inflation because it preserved its value, and whilst investors will often still buy Gold for its safe-haven properties in times of extreme market turmoil, this is not the case most of the time. This is because when inflation is high, central banks will put up interest rates to combat it.
Higher interest rates are negative for Gold because they increase the opportunity-cost of holding Gold vis-a-vis an interest-bearing asset or placing the money in a cash deposit account. On the flipside, lower inflation tends to be positive for Gold as it brings interest rates down, making the bright metal a more viable investment alternative.

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