Euro Higher after Eurozone Inflation Falls

It has been a quiet week for EUR/USD which continues to say close to the 1.09 line. The lack of activity could change in a hurry in the North American session, with the Fed rate announcement.

Eurozone inflation slides in January

Eurozone inflation is expected to be 8.5% in January, down from 9.2% in December and below the consensus of 9.0%. The key driver behind the decline was energy prices, which rose 17.2% in January, compared to 25.5% in December. Core CPI remained at 5.2%, a notch above the consensus of 5.1%. On a month-by-month basis, Core CPI fell by 0.8%, compared to a 0.6% gain in November and below the forecast of -0.2%.

Today’s inflation report is the final key event ahead of the ECB rate decision on Thursday. It’s practically a given that the central bank will raise rates by 50 basis points, bringing the cash rate to 3.0%. After that, the pace of monetary tightening will depend largely on the strength of the eurozone economy and inflation levels. The ECB will be pleased with the drop in headline inflation but concerned that the core rate has been stickier. Germany, the locomotive of the bloc, released dismal numbers this week. Retail sales crashed, with a decline of 5.3% while GDP came in at -0.2%. If German numbers remain weak, the ECB will have to consider easing up on rates with modest hikes of 25 basis points rather than 50-bp moves. The markets are forecasting a terminal rate in the range of 3.25%-3.75%.

All eyes are on the Federal Reserve, which is widely expected to raise rates by 25 basis points. This would bring the benchmark rate to 4.75%. Inflation in the US fell to 6.5% in December, marking six straight months of de-acceleration. It appears that inflation has peaked, although the Fed won’t be using the “P” word for fear of an excessive reaction from the markets. The Fed has been more hawkish about rate levels than what the markets have priced in, and if Jerome Powell reiterates this hawkish stance, the markets could be in for a cold shower which would be bullish for the US dollar.

EUR/USD technical

• EUR/USD is testing support at 1.0878. Below, there is support at 1.0826.
• 1.0921 and 1.1034 are the next resistance lines.