Euro Threatened as German Consumer Prices Point to Deflation (Euro Open)

The Euro may see selling pressure as the final revision of Germany’s EU-harmonized consumer price index slips into negative territory for the first time since the creation of the single currency, threatening the Euro Zone’s largest economy and thereby the region as a whole with the prospect of deflation.

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

[B]• Australian Consumer Confidence Rises Most in 22 Years, Says Westpac
• New Zealand’s Trading Terms Index Tumbles on Weak Export Demand[/B]

Critical Levels[/B]

The [B]Euro[/B] traded sideways in Asian hours, oscillating in a 40-pip band above 1.4050 to the US Dollar. The [B]British Pound[/B] followed suit with prices confined to a narrow 0.3% band above 1.63.

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

Australian [B]Consumer Confidence[/B] surged 12.7% in June, the largest monthly gain in over 22 years, according to Westpac Banking Corp. More notably still, the metric’s value topped the “boom-bust” 100 level, suggesting optimists outnumber pessimists among the 1200 consumers polled for the survey for the first time since January 2008. Westpac’s chief economist Bill Evans called the result “truly remarkable” but qualified that “this surge in confidence can be seen as a delayed response to the significant stimulus over the last nine months.” Indeed, the forces behind June’s result have been revealed since traders learned that GDP unexpectedly grew in the first quarter, boosted by the government’s generous stimulus efforts. The real question going forward will be whether Australia is able to sustain positive momentum after the flow of stimulus cash dries up. Evans seems to share our cautious assessment, saying “the positive confidence reaction in June is probably premature [considering] domestic spending fell 1 percent [in the first quarter despite the positive headline figure], the sharpest fall since the December quarter of 2000.” A survey of economists conducted by Bloomberg suggests the economy will shrink for the remainder of 2009.

New Zealand’s [B]Trading Terms Index[/B] fell -3.0% in the first quarter, the most in nearly 7 years. Import prices fell 5.4%, while those for exports declined 8.2%. The New Zealand dollar ended the three months to March moderately higher (1.08%) against a trade-weighted basket of top currencies, suggesting the fallout owes to sluggish demand for the country’s exports. Exports account for about 30% of the antipodean nation’s total output, so continued weakness here is likely to stall any prospects for a robust economic recovery in the near term. Economists expect the Reserve Bank of New Zealand will keep interest rates unchanged at 2.50% later this week but recent commentary from bank officials suggests there is ample room for a surprise reduction.

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

The final revision of Germany’s [B]Consumer Price Index[/B] is set to confirm that inflation fell -0.1% in May to bring the annual pace of price growth to a standstill for the first time in at least 17 years. The adjusted version of the metric using a harmonized EU methodology is set to show an even more ominous result, confirming that the annual pace of German inflation shrank -0.1%, the first negative outcome since the creation of the Euro. The onset of deflation in the Euro Zone’s largest economy is a scary prospect for the single currency: if expectations of falling prices become entrenched, Germany may find itself treading water for longer than expected as consumers and businesses wait for the best possible bargain and perpetually hold off on spending and investment; the massive weigh of Germany as driver of economic growth for the Euro Zone as whole means that the bloc’s performance will remain subdued as well, pushing expectations for higher interest rates farther out into the future to hurt the European unit against UK and US counterparts. Indeed, overnight index swaps show traders are pricing in expectations that the Fed and the Bank of England will deliver 100 basis points in rate hikes over the next 12 months while the European Central Bank lags behind with just 61bps in the same period.

Turning to the UK, the [B]Trade Balance [/B]is expected to narrow to 2.4 billion pounds in April from 2.5 billion in the previous month. Considering export volumes have been trending sharply lower, down 9.7% to date since peaking in July last year as the global economic downturn crushed overseas sales, it stands to reason that absent a recovery in foreign demand (an unlikely scenario considering the UK’s top trading partners are mired in deep recession) any improvement in the headline figure would come from lackluster import readings. Another drop in [B]Industrial Production[/B] fits very neatly into this picture: output is set to shrink at an annual pace of -12.4% for the second consecutive month in April, the most in at least 33 years, largely on weak exports. This speaks directly to the current spending client, revealing that consumers remain on the defensive despite a stronger Pound that would have made foreign-made goods comparatively cheaper. As with most advanced countries, private consumption is the largest component of overall UK economic growth and continued weakness here is likely to keep a lid on any moves towards a sustainable from the current downturn. Indeed, the latest forecasts call for the economy to continue to shrink at least through the first quarter of next year.

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