Monthly wrap: EUR – Negative Eurozone inflation boosts odds of ECB action

Key Takeaways:

• Negative Eurozone inflation weighs on euro demand
• Single currency vulnerable to dovish signals from European Central Bank
• EUR Monthly lows: £0.89, $1.16, C$1.54, A$1.61, NZ$1.74
• EUR Monthly highs: £0.92, $1.19, C$1.57, A$1.65, NZ$1.78

 
As the headline Eurozone consumer price index fell short of forecasts, this exposed the euro to a fresh bout of selling pressure.

Investors were discouraged to find that the inflation rate had dipped more than expected to -0.3% on the year in September, although markets had anticipated another negative reading.

With inflation continuing to trail significantly below the European Central Bank’s (ECB) 2% target, this weak reading further increased pressure on the central bank to consider further policy action.

Demand for the single currency also weakened in the wake of comments from ECB President Christine Lagarde, who noted that the central bank is ‘monitoring’ the relative strength of the euro.

Speculation that the ECB could intervene to weaken EUR exchange rates, in order to help protect the Eurozone’s economic recovery from the Covid-19 crisis, weighed heavily on sentiment.

Even so, signs of resilience within the German manufacturing sector and Eurozone retail sales kept a floor under the euro over hopes of a stronger third quarter growth performance.

An uptick in October’s ZEW economic sentiment index may offer EUR exchange rates another rallying point in the days ahead.

As long as businesses show greater signs of confidence in the outlook of the economy this should give investors less incentive to sell out of the euro.

However, a narrowing of the Eurozone trade surplus in August could cast another shadow over the economic outlook.

The possibility of further Covid-19 restrictions being reintroduced over the winter months in response to a second wave of infections may also drag on the euro.

Unless investors see reason to bet that the Eurozone economy can return to a sustained state of growth in the second half of 2020, this may limit the potential for EUR exchange rate gains.

While interest rates are unlikely to see any alteration at the ECB’s October policy meeting, the nature of policymaker commentary could push the euro into a fresh decline.

If the central bank signals its intent to deliver further monetary loosening measures before the end of the year, EUR exchange rates look set to falter.