US CPI and the ECB Meeting To Spark Volatility

First up on Wednesday will be the release of the latest US inflation figures which is the last piece of the major data puzzle before the FOMC meeting next week.

The headline inflation rate inched up in July for the first time in more than a year and this uptrend is likely to continue due to rising energy costs. Gasoline prices will be a big driver by adding several tenths of a percentage point to CPI. But shelter costs are expected to trend lower as the lagged effects of weaker market rents impact. The print will still be well below the annual rate which peaked at 9.1% in June 2022.

The annual core rate should slip lower towards 4% and the lowest since October 2021. Another 0.2% core monthly reading would please the Fed as it would be the third straight month of soft underlying inflation. That would also imply the trend rate is nearing their 2% target, a goal which had seemed so far away a year ago when markets were battling with monthly prints four and five-tenths higher.

The longer-term disinflationary trend is expected to reinforce expectations that the Fed pauses at next week’s meeting. Further out, the odds for a 25bp November rate hike were boosted after the upbeat ISM services PMI last week. But a strong upside inflation surprise would shift the current near 60/40 bet further in favour of more policy tightening.

ECB’s Tight Call

It’s a tough decision to hike or keep rates unchanged for the ECB when it announces its rate decision on Thursday. Money markets currently favour the status quo with around a 40% chance of a 25bp rate hike. That would be the bank’s tenth consecutive rate rise and take the deposit rate to 4% with cumulative tightening of 450bps since last July.

President Lagarde and the Governing Council switched to a data dependent stance in July at their previous meeting. Since then, both the data and speeches by officials have provided ammunition to the hike and pause camp. The growth picture is deteriorating with recent PMI survey data pointing to a grim outlook, especially in Germany. But core inflation is still high and running at more than double the ECB’s target. Updated ECB staff projections will likely show above target inflation over the policy horizon, thereby supporting a rate rise. The tone of the statement may also emphasise that rates will be held in restrictive territory for as long as necessary.

However, headwinds on the horizon, coupled with higher oil prices and a weakening China may warrant a more cautious bias by Lagarde in the press conference. That could see the euro sink further against the dollar after eight straight weeks of losses. Waning growth momentum and the lagged effect of previous hikes could then set up a pause for the October meeting.

The Technicals…

Since conquering the 1.0800 support level, euro bears have stepped into higher gear with prices slowly approaching the 1.0670 support level. The EURUSD is heavily bearish on the daily charts with the candlesticks trading below the 50,100 and 200-day SMA. However, the Relative Strength Index (RSI) is signaling that prices are oversold on the daily timeframe. Key levels of interest can be found at 1.0520, 1.0670 and 1.0800.

Written on 12/09/2023 by Lukman Otunuga, Senior Research Analyst at FXTM

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