EUR/USD: Euro-zone CPI Set to Make or Break ECB Rate Hike Expectations

[B]AUG 16[/B]
[B]Euro-zone CPI (MoM) (JUL) (05:00 EST; 09:00 GMT)[/B]
[B]Euro-zone CPI (YoY) (JUL) (05:00 EST; 09:00 GMT)[/B]
[B]Expected: -0.2%[/B]
[B]Expected: 1.8%[/B]
[B]Previous: 0.1%[/B]
[B]Previous: 1.8%[/B]

[B]How Will The Markets React?[/B]
Inflation growth in the Euro-zone is expected to slow during the month of July, with CPI estimated to have fallen 0.2 percent from the month prior, while the annualized rate is expected to hold steady at 1.8 percent. There are risks to both the upside and downside for this particular release. First, French CPI for the same month dropped more than expected - which could weigh the broader Euro-zone index down - led by a fall in food, tobacco, and manufactured goods prices. On the other hand, the German wholesale price index - a measure of inflation one step back from the front line consumer - grew at a faster-than-expected 0.4 percent during the month. As the Euro-zone?s largest economy, shifts in German economic data tend to be a good leading indicator for releases encompassing the entire region. As a result, traders should also keep an eye on German CPI which is scheduled to be announced at 2:00 EST on August 16th, as a surprising release could signal an unexpected Euro-zone CPI figure just a few hours later. Recently, speculation has flown that a global credit crunch, which encouraged the European Central Bank to inject liquidity into the European markets, would defer or else cancel the highly anticipated September rate hike. However, ECB President Jean-Claude Trichet, who signaled a rate increase by reinserting the phrase “strong vigilance” into his rhetoric, is not one to go against his word. As a result, it may take an even sharper decline in Euro-zone price pressures to curb the ECB?s hawkish bias.
[B]Bonds - 10-Year German Bund Futures
Bunds pushed up against Fibonacci resistance at 113.15 today, as continued risk aversion worked in favor of government bonds. The sharp turnaround from yesterday?s low gives daily charts a much more positive bias, as price broke the series of lower highs posted this month. Nevertheless, event risk out of the Euro-zone creates hazards for bunds, as a major shift in inflation data could either add to or curb speculation of a hike by the ECB in September. As a result, signs that CPI remains strong could lead the contract back down towards the 112.00 level, as the news would only underpin ECB President Trichet?s concerns regarding inflation risks. On the other hand, a weaker-than-expected reading has the potential to send bunds rocketing up towards 114.00.

[B]10-Year German Bund Futures (Daily Chart)[/B]

The EUR/USD pair continues to plunge lower, breaking through support at the 100 SMA at 1.3553 and testing an ascending trendline at 1.3456, as risk aversion trends have moved in favor of the US dollar. Furthermore, weaker-than-expected Euro-zone GDP did not help the case of the European currency, especially as the chances of a rate hike by the European Central Bank have already been diminished since global financial markets were sent reeling amidst fears of a liquidity crunch. While EUR/USD looks hesitant to break near-term support, the release of Euro-zone CPI will add major event risk to the pair. The first thing traders should keep in mind when trading the release is that the knee jerk reaction will likely be in line with the data. For example, a strong CPI reading could send EUR/USD spiking higher for a test of 1.3500 while a surprisingly weak CPI report may lead EUR/USD spike down towards support at the 200 SMA (currently at 1.3326). The other factor to consider is the longer-term perspective, as the immediate price reaction may not see any continuation. By and large, the US dollar still remains oversold (see the most recent COT report here ), and with the currency turning into an apparent safe-haven at times of major market volatility, the trend could continue to take EUR/USD far lower throughout the next few months. Moreover, a Euro-zone CPI reading that shows a contraction in price growth would only perpetuate such a move.
[B]EUR/USD (Daily Chart)

[B]Equities - Xetra DAX 100 Index[/B]
German equities outpaced those in the UK and France on Wednesday, as the Xetra DAX gained 0.3 percent while the FTSE 100 lost 0.6 percent and the CAC 40 dropped 0.7 percent. The 7,300 has held up as steady support for the DAX thus far, but Euro-zone inflation data due to be released, that price level could easily be broken. CPI is anticipated to soften in July, which could lead to some market speculation that the European Central Bank will refrain from hiking rates in September and could add to strength in the German equity index. On the other hand, ECB President Trichet made intent to hike very clear earlier in the month, and if inflation pressures remain strong, a 25 basis point rate increase to 4.25 percent will be essentially guaranteed and could push the DAX to either test or break 7,300, with additional support looming at the 200 SMA at 7,102.
Xetra DAX 100 Index (Daily Chart)


[B]Written by Terri Belkas, Currency Analyst[/B]