Tomorrow, Germany reports CPI figures for July. That gives us a first look at what to expect from inflation data out of the EuroZone to be released on Wednesday. The consensus is for another increase, which would help firm up the case for another 50bps hike by the BCE at their meeting in two weeks. This is the last major inflation data the central bank will have before they decide on what to do with monetary policy.
Last week, the ECB released minutes from their July meeting, showing they intended to keep tightening. That also implies that a “double” rate hike is likely. Unless there is a major shift in the data, that would catch everyone by surprise. The expectation is for inflation to get worse in the shared economy, both in the headline number and core reading.
Starting with Germany
The largest economy in the EuroZone is often seen as a bellwether for the rest of the shared economy. This is particularly relevant around the inflation figure if it is rising, since as a rule, Germany tends to have more fiscal discipline. If German inflation is rising, chances are that inflation in the rest of Europe is rising even faster. If prices were to get under control, most likely that would be seen in Germany first.
German CPI change for August is expected to show an annual rate of 7.8%, higher than the 7.5% reported in July. Germany has a more regulated energy sector, and is less likely to see the benefits from lower fuel prices that helped reduce inflation in the US during the same period. At the same time, German regulators also allowed for energy companies to pass on more of the cost to consumers. Where there could be good news is that monthly inflation is expected to slow to 0.4% compared to 0.9% in the prior month.
 What’s driving the market
Wednesday could be a pretty lively day for the markets, because we get CPI data and PMI figures through the course of the day. We’ll get into more detail on the PMI numbers tomorrow. For now, inflation is likely to have the bigger impact on the EURUSD as it is driving the main divergence between the currencies of the two largest economies.
Last month, EU inflation already surpassed inflation in the US. Meanwhile, the interest rate gap between the two economies continues to grow, as the Fed has been more aggressive in taming inflation. That means real yields in the US have been increasing, while real yields in the Euro have been decreasing. The fluctuations in inflation are bigger than the interest rate policy moves, meaning that inflation is driving the yield spread. Which, in turn, drives the relative price dynamics of the EURUSD. As long as real rates are weakening in the Euro, the pair is likely to be under pressure, and find it hard to get back above parity.
The data to pay attention to
The EuroZone is expected to report a modest increase in CPI change to 9.0% from 8.9% prior. The core rate is expected to rise by a similar measure to 4.1% from 4.0%, double the target rate. To make matters more difficult for the ECB, the monthly inflation rate is expected to accelerate to 0.6% from 0.1% prior.
Inflation rising faster on the monthly basis, and the change being seen in the core numbers, implies a more structural problem. The market already expects the ECB to raise rates, so higher inflation likely won’t be all that much of a surprise. But if CPI change were below expectations, then it could have some monetary policy implications.
