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Euro’s Fate Rests in ECB Message Between the Lines: Macro View

(Bloomberg) — The days of euro strength may be numbered if the currency’s advance takes a toll on the European Central Bank’s inflation forecasts due this week, which would in turn cast doubt over the timing of stimulus tapering.

  • EUR/USD has risen more than 7% since May 16, the cut-off date for ECB staff projections in June; those forecasts put EUR/USD at 1.08 this year and 1.09 in 2018-2019; meanwhile, HICP inflation was expected to average 1.5% in 2017, dip to 1.3% next year and 1.6% in 2019
  • Euro gains raise the likelihood of an upward revision to the central bank’s currency forecasts, and a turn lower in inflation projections — a strong signal tapering may be pushed back until price gains pick up
  • That comes as policy makers increasingly appear in no rush to make a decision on the bond-purchase plan, which will cap euro gains
  • If the ECB keeps its inflation forecast largely unchanged despite the currency’s strength, it implies policy makers expect domestic demand to pick up the slack. That would signal tapering — and further normalization down the line — is still on the table, hence supporting the euro’s advance
  • Beyond economic data, a major contributor to the EUR/USD advance has been receding euro-area political risks coupled with turmoil in Washington
  • If this continues, verbal push back from the Governing Council can be expected (Nowotny’s sanguine tone on Friday, notwithstanding). That, combined with lower inflation forecasts, could be a powerful antidote to a strong currency
  • NOTE: Richard Jones is a markets strategist and blogger for Markets Live. The observations he makes are his own and are not intended as investment advice

To contact the reporter on this story: Richard Jones in London at rjones207@bloomberg.net To contact the editors responsible for this story: Paul Dobson at pdobson2@bloomberg.net Kristine Aquino

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