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Jignesh Davda

German Economy Falters as Manufacturing Continues to Decline

The largest economy in Europe is under increasing pressure as Markit reported Flash Manufacturing PMI figures declining to a seven-year low.

The Composite Output Index, which is a blend of both Services and Manufacturing, declined to 51.4 in July from 52.6 in the prior month. While the figure has dropped, it remains above 50 which indicates growth.

The Services PMI declined to 55.4 from 55.8 in June, while lower, also still showing growth. What is weighing on the composite index is the Manufacturing PMI as it declined to 44.1 which reflects an 84-month low. The Manufacturing PMI in Germany has contracted for seven consecutive months.


The European Central Bank Meets Thursday

The weaker German data brings to the forefront the theme of weak global growth. The ECB, who will meet on Thursday, will need to decide if action is appropriate to combat this trend along with subdued inflationary pressure and the risks presented by an ongoing trade war.

Another risk the central bank is faced with is yesterday’s announcement of Britain’s new PM, Borish Johnson. He has promised to lead the UK out of the EU even if it means it is done without a deal. This certainly generates risk to the Euro economic outlook.

Technical Analysis

Monetary policy has been a big driver for EUR/USD. Last month, expectations were increasing for an aggressive rate cut in the United States. At the same time, the ECB delivered a much less dovish outlook at their last meeting.

Ahead of this week’s meeting, market expectations of dovish forward guidance from the European central bank have increased quite a bit compared to last month. At the same time, the markets have pared back expectations for a 50 basis point cut from the Fed.

EUR/USD is approaching a critical support level at 1.1118. This level held the pair higher in April and in May. I suspect the pair will struggle to break below it, at least ahead of the ECB meeting.

Yesterday, the pair broke down from a 1-week range after slicing through support at 1.1184. The pair closed below the level on a daily basis which further points to weakness.

At the same time, I think it is important to consider that EUR/USD has been trading in a range for most of the year. For this reason, I think a continuation of the downward momentum will require a catalyst.

Bottom Line

  • EUR/USD is nearing important support at 1.1118 ahead of Thursday’s ECB meeting.
  • Ultimately, a dovish ECB can provide the needed catalyst for a continuation lower
  • The markets are expecting the ECB to be much more dovish than last month. In this context, the bar is set high for tomorrow’s meeting.
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