Euro tumbles on strong US inflation, employment and housing data
26/May/2015 • Currency Updates•
The Euro suffered its worst week in years, falling over 3% against the US Dollar and by about half that amount against Sterling. The gulf between monetary policies across the Atlantic has once again become the main driver of Euro weakness, as US data, and communications from Federal Reserve officials, point more and more to a first increase in US rates sometime in the summer or fall of this year.
By contrast, the European Central Bank suggested that monetary easing in the Eurozone would be front loaded and purchases of bonds would actually increase over the next few months. The single currency received no relief on the Greek front, where Greece warned that it will not make the payments due to the IMF in June, unless an agreement is reached with creditors.
Last week saw mixed economic news coming out of the UK.
Headline inflation in April came out negative. The core number, which strips out the more volatile components of food and energy, surprised to the downside dropping 0.2% to 0.8% to a new cycle low. The drop in core inflation is a sign that currency strength is filtering through to lower prices of imported goods. It should be remembered that the negative print in inflation was largely anticipated by the Bank of England, so this should have little effect in the timetable for interest rate hikes.
Furthermore, retail sales in April were surprisingly strong, rising 1.2 on the month and confirming that consumer spending is growing at a rate of above 3% in real terms. This positive data helped Sterling continue its rebound against the Euro, although the Pound could not keep up with the massive Dollar rally and cable fell back below the 1.55 level.
In addition to the hawkish noises from the Federal Reserve and the ECB’s announcement regarding stepped-up bond purchases, the common currency was hit by a spate of negative economic data.
The key PMI indicators of business sentiment suffered a setback in May, with the composite index falling back half a point to 53.4. This is not a dramatic fall, but it confirms that the upward trend has now been broken and suggests that the Eurozone economy will struggle to accelerate further from modest (and likely insufficient) growth levels. The final inflation numbers for April were confirmed at exactly 0.0%; more worrisome was the widening gap between core countries and those in the periphery, which seems to be firmly stuck in a deflationary trap.
In addition to the Greek stalemate, the common currency received further bad political news from Spain. On Sunday’s local elections, the anti-austerity coalition Podemos came in first in both Madrid and Barcelona, and will hold the key to governing many of the regional administrations. It is increasingly clear that patience with austerity policies and Troika-inspired reforms is running out, and that Eurogroup efforts to paint Greece as an exceptional case are unconvincing.
There appears to be little to stop a resumption of the Euro downward trend, particularly since the IMM commitment of traders report indicated that the overhang of USD long positions has been largely cleared out.
Last week’s macroeconomic releases in the US provided plenty of ammunition for those Federal Reserve officials who are pressing for interest rate hikes sooner rather than later.
While headline inflation for April printed just 0.1%, the more relevant core number, which strips out volatile food and energy, came out at a higher than expected 0.3% on the month. This means that the three-month annualized rate of core inflation has now accelerated from barely above 1% to 2.6% in just five months.
Further signs that rate levels in the US need to be normalized came from the labour market. The weekly number of first-time claims for jobless benefits, which is perhaps the best high-frequency indicator of the health of the labour market, continues to print new lows almost every week. The four-week average is now the lowest since the early 1970s, at 266,000.
Further confirmation that the US economy is emerging from the winter doldrums came from the housing market. April housing starts and new permits surged and have now recovered much of the ground lost in the first quarter.
All in all, numbers are clearly supportive of our view of a first interest rate hike in July of this year, which will continue to provide strong support to the US Dollar.