EURGBP How far the bounce

The US dollar made notable gains as US new home sales regained the 500K mark for the first time in seven years and inflation bounced […]

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By :  ,  Financial Analyst

The US dollar made notable gains as US new home sales regained the 500K mark for the first time in seven years and inflation bounced from negative territory to 0%, showing its first improvement in nine months. Broad improvements in Eurozone PMIs were led by Germany, propping EURUSD to $1.1020s before US data erased all the gains. The pound was the biggest loser as UK CPI fell to zero%, the lowest on record.

Eurozone PMI raises GDP forecasts

More signs of green shoots in the eurozone as the flash March PMI composite (combines services and manufacturing) hit a 46-month high of PMI 54.1, defying expectations of 53.6. The services PMI surged to a 46-month high at 54.3, while the manufacturing PMI hit a 10-month high at 51.9.

Germany’s services and manufacturing PMIs continued to strengthen, boosting the composite PMI to 8-month high of 53.8. In France, services remained the only bright spot on as manufacturing weakness dragged down the composite PMI to 2-month lows.

The plunging euro, improving consumer /business confidence, increasing liquidity rank among the major factors inducing the upturn in PMIs. Economists have revised their Eurozone Q1 GDP forecasts to as high as 0.4%, which would be the strongest in 4 years. This follows +0.3% in Q4.

More good news could be seen in Wednesday’s release of Germany’s IFO business sentiment survey, expected to show further gains in each of its three components (business climate, current assessment and expectations)

UK disinflation is now official

UK CPI fell to zero% in February, hitting the lowest annual rate since comparable records began in 1989. Falling oil prices kept producer prices negative in February, but even when removing excluding energy prices, inflation on at producer level was low, which means that disinflationary pressures are increasingly creeping into the production line and may inevitably extend into the retail space.

The inflation figures justify some BoE members’ increasing references to “deflation” risks, especially last week’s comments from the bank’s chief Economist Andy Haldane, indicating “…a case can be made for policy easing today” if downside risks to inflation were to materialize.

Despite the pound’s 15% decline against the US dollar since last summer’s highs, the currency has appreciated as much as 20% against the euro over the last 12 months, which helps explain the BoE’s worries of importing deflation from Eurozone and exacerbating deflationary pressures at home.

US inflation back up to zero

US CPI also hit zero% in the year ending in February, but showed its first rise in nine months, following prolonged oil-driven declines. The fact that core CPI (excluding volatile food and energy items) edged up to 1.7% from 1.6%, highlights the disinflation-bound trend in US retail prices to be largely driven by falling oil, suggesting that continued stabilization in energy prices could lift headline CPI back towards the 1.0% level.

Whether such hypothetical improvement would be sufficient in bolstering the case for the doves at the Fed remains unlikely for now. It would require an (unlikely) sharp and prolonged rally in oil prices in order for headline CPI to approach the Fed’s 2.0% objective and pave the way for a lift-off in US interest rates.

EURGBP bottoming process

EURGBP’s 5% rebound of the last 2 weeks could gain more momentum if the BoE steps up its dovish rhetoric and raises the tone over currency concerns. Not only deflation in the eurozone is an “older” issue than it is in the UK, but Eurozone CPI may appeared to have bottomed in January at -0.6% before stabilizing to -0.3% in February. The picture is already reflected in the narrowing EU-UK 10- year yield spread, which shrank to -1.19% from last month’s record high of -1.64%. If the Eurozone/UK inflation differential continues to widen in favour of the euro, then both the EU/UK yield differential and EURGBP could remain supportive in favour of a return towards 0.7700

EURGBP Monthly Mar 24 2015

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