The EURUSD relentless bid continues so far in September – it started the month on a tear higher, knocking at the 1.20 door. The pair pushed against tough resistance for the entire summer, with 1.20 acting as a major, pivotal level.
Who would have thought that in only a few months, the most liquid and popular currency trading pairs would travel over a thousand pips? Considering the burden of a strong currency on the regional inflation, this is hardly a thing for a central bank to tolerate.
And, it did not.
Core Inflation Dropping to Record Lows In the Eurozone
Two main events happened yesterday that may have capped the EURUSD advance for a while. First, yesterday we saw the HICP or the inflation numbers coming out of the Euro area.
This is the metric the ECB uses to calibrate its inflation expectations and, eventually, the inflation rate that truly matters when setting the interest rate policy in the Eurozone. Moreover, the ECB looks at the core rate – the one that does not consider energy prices, for instance, as they are too volatile and distort the data.
It came out at record lows. Not only was the data disappointed, but it printed 0.4% on expectations of 0.9% and falling from 1.2%. This is the YoY estimate and usually traders are fooled by the expected number. However, the focus should be on the difference between the previous print and the actual. Or, between 1.2% and 0.4%. A sharp drop like this cannot be ignored nor accepted by the ECB, who’s main mandate is price stability around the target – the 2% inflation target. This is anything but close to 2%, and makes the next week’s ECB decision and press conference suddenly very interesting.
Fast forward a couple of hours later, and the ECB’s chief economist Lane said that the ECB does not target a specific FX rate, but the EUR/USD rate matters. Boom.
Just like that, the EURUSD reversed course. It dropped a hundred points ever since the statement came out, with little or no support until the 1.19 area.
Sure that the FX rate matters. Imagine a central bank struggling to bring inflation to 2% and failing. The result is a loss of credibility – a big deal for an independent central bank. When the currency keeps getting stronger, not only that it weighs on inflation
, but it weighs on the ECB’s credibility too.
When inflation drops to 0.4% and threatens to reach deflationary territory.