Euro in Focus as German Producer Prices Stoke Deflation Expectations (Euro Open)

The Euro may see selling pressure in overnight trading with German Producer Prices set to fall -3.6% in the year to May, the largest decline in 22 years, stoking expectations that the Euro Zone’s largest economy will help drag the currency bloc into deflation, containing economic growth.

[U][B]Key Overnight Developments[/B][/U]

[B]• Meeting Minutes Show BOJ Remains Uncertain About Domestic, Global Economy
• Euro, British Pound Range-Bound Against US Dollar in Overnight Trading[/B]

[U][B]Critical Levels[/B][/U]

The [B]Euro[/B] consolidated in a narrow 40-pip range in overnight trading, oscillating around the 1.39 level. The [B]British Pound[/B] followed suit, trading sideways in a 100-pip band above 1.63.

[B]Related Article:[/B] US Dollar Positioning Increasingly Bullish Against Forex Majors

[U][B]Asia Session Highlights[/B][/U]

Minutes from the last meeting of the [B]Bank of Japan[/B] revealed policymakers are far from optimistic about the world’s second largest economy. On exports, the BOJ stated that overseas sales are expected to “level out…mainly due to progress in adjustments in local inventories,” meaning the bank sees little chance of a meaningful rebound in global demand for the time being. On private consumption, the BOJ said spending was “likely to remain relatively weak…as the employment and income situation [becomes] increasingly severe,” chalking up the recent uptick in consumer confidence to “various demand-boosting policy measures” (i.e. government handouts). On the financial markets, the bank acknowledged that “there had been some easing of tension” but maintained that conditions remain tight, saying that “the stimulative effects from [monetary easing] had been limited.” On balance, the BOJ concluded that “the outlook [for Japan going forward] was attended by a significant level of uncertainty, given that economic activity was likely to be strongly affected by developments in overseas economies and global financial markets.”

Euro Session: What to Expect[/B][/U]

German [B]Producer Prices[/B] are set to fall -3.6% in the year to May, the largest decline in 22 years. The reading foreshadows continued downward pressure on consumer inflation as cheaper wholesale prices are passed on via a lower final price tag. German CPI came to a standstill in May and is poised to head into negative territory from here. The onset of deflation in the Euro Zone’s largest economy is all but certain to take region-wide inflation along the same trajectory, threatening to commit the currency bloc to a long-term period of subpar economic growth as consumers and businesses are encouraged to wait for the best possible bargain and perpetually delay spending and investment.

As we noted last week, the present situation argues for a far more forceful monetary response than anything that has been introduced by the European Central Bank thus far. Overnight index swaps suggest that traders are pricing in virtually no chance that the ECB will lower rates at the next policy meeting and quantitative easing will be difficult to expand beyond the modest measures announced earlier this month given the internal conflict about such policies within the central bank. This opens the door for traders to punish the Euro as they price in expectations that the region will substantially lag behind other industrial economies in recovering from the current downturn, forcing interest rates to stay lower for longer than elsewhere.

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