- With ECB in the rearview mirror, growth and politics will drive euro currency trading
- Inflation continues to decelerate, but may have turned a corner
- Politics looks mostly negative, with Germany turning inwards following elections
Following the conclusion of the French elections earlier this year, in the forex market, the euro has strengthened based on expectations of the ECB tapering its quantitative easing program. After last Thursday’s ECB meeting (and disappointment), the Bank is set to remain in the background until the second half of 2018. Looking at the latest Commitments of Traders report, speculators have already pared down some of their euro currency long positions, and are likely to keep selling euros in the near future. With falling speculator interest and limited hopes for tapering, economic data and politics are likely to drive EUR trading in the near future.
Earlier today, Eurostat announced its first estimate for Q3 GDP growth and inflation data for the Eurozone. As several Eurozone members have not yet announced their preliminary Q3 growth figures (Germany and Italy in particular), Eurostat’s first estimate is subject to changes. This has been the case historically and remains true today.
Growth accelerates to rates last seen in 2011, impacting the euro currency forecast
Positively impacting euro currency news, latest growth figures were very good, showing that the Eurozone grew 2.5% year-over-year in Q3 2017 and beating estimates of 2.4%. Recent data relating to GDP growth, such as German retail sales and Eurozone manufacturing PMIs, have been strong and suggests that overall growth remains solid. Today’s figures are particularly impressive given that prior growth rates were also quite good in 2016. Overcoming the adverse base effects from last year is no small feat for the region. An overview of annualized growth rates since 2012 is shown below:
Up and up: Eurozone growth has made an impressive comeback
Inflation news disappoints, but its trajectory may be changing
Unlike growth numbers, inflation data remains disappointing. Looking at year-over-year figures, the first estimate of October headline inflation is 1.4% while core inflation is 0.9%. Both figures came in below consensus (1.5% and 1.1% respectively), suggesting that inflation continues on a decelerating path despite the ongoing acceleration in growth rates. While the results missed estimates, the silver lining is that headline inflation is turning a corner. After decelerating down to 1.1% in September, an acceleration to 1.4% may be a sign of things to come. Given our bullish outlook on future inflation as a result of rising crude oil prices, our view is that today’s deflation fears may be unwarranted. If growth and inflation accelerate in tandem in Q4 2017, the outlook for the euro based on economic fundamentals is bullish. An overview of annualized Eurozone inflation rates, by month, is shown below:
Turning a corner? Headline inflation changes its trajectory
Economic data helping the euro trading forecast, but politics mostly a negative
With growth heading in the right direction and inflation potentially turning a corner, the remaining issue is politics. While Macron’s success in the French presidential elections led to hopes of increased political unity amongst Eurozone members, the outcome of the recent German elections has put these aspirations into question. As the Eurozone’s largest and strongest economy, efforts to increase the political power of the union ultimately requires German consent.
While Merkel had shown signs of agreeing with Macron’s vision for Europe prior to the national elections, this is no longer the case today. After the CDU/CSU party lost ground to the far-right AfD party, Merkel will have to form a coalition government in order to remain in power. Reuters is reporting that coalition negotiations between CDU/CSU, the Free Democrats (FDP) and the Greens have been challenging. Given the FDP’s right-wing credentials, the party is particularly allergic to demands from the Green party to allow family reunification for refugees settled in Germany. More relevant to the euro forecast, the FDP is also firmly opposed to any closer budget or fiscal ties with other Eurozone members.
As Germany turns inward, hopes for coordinated Eurozone fiscal expansion seem less likely. Assuming the FDP sticks to its ‘red lines’ regarding more fiscal ties amongst Eurozone members, the outcome from politics is likely to have a negative impact on euro currency trading.
Final word on euro trading
Despite the fact that economic data is trending in the right direction, the euro may be undermined by recent developments in national politics. The combined impact of these two factors means that the outlook for the euro looks mixed today.