Euro Zone Inflation Continues its Rebound

Daily Analysis - 18/10/2016

Rising Consumer Prices Raises Speculation of an ECB Taper As Asset Purchase Program Reaches Maturity

Consumer price inflation in the Euro accelerated to the fastest pace of growth in years as continued asset purchases alongside a highly accommodative monetary policy backdrop set the stage for further gains in the key rate. However, a shortage of purchasable assets might derail the ECB’s ability to expand the program when it is set to expire in March.

Euro Headline Inflation Accelerates Higher

According to the latest figures reported by Eurostat, headline consumer prices edged higher to a 0.40% pace of increase on an annualized basis. Besides accelerating to the fastest pace of price gains since October of 2014, an improving trend could foreshadow potential tapering of asset purchases when the existing program is set to expire 2017. Although most economists and analysts are calling for an extension of the program, the problem lies in the supply of available assets for the current program. Due to the ECB’s rules that it cannot purchase assets yielding less than the deposit rate of -0.40%, many potential assets are excluded. Unless the terms of the program are adjusted, the ECB may run out of available assets to buy. If that happens, the Euro may rally significantly as the Central Bank adds less liquidity to financial markets.

Australian Accommodation Depends on Prices

With inflation the main sticking point for most global central banks in the current monetary environment, the Reserve Bank of Australia is no different in its outlook for policy. In its meeting minutes released overnight, the Central Bank highlighted the dependence on upcoming inflation and employment figures before determining whether further rate cuts were appropriate. Remarks from newly installed RBA Governor Philip Lowe asserted that he was relatively content with the current exchange rate environment, shifting away from his predecessor’s stance that the Australian dollar remained overvalued. In many respects, this comment sparked lessened speculation of November action on rates, especially after he diminished the risk of low inflation. However, with CPI and employment data due ahead of the November 1^st meeting of the monetary policy committee, the stance may change. In the meantime, the AUDUSD is higher following the statement on exchange rates.

US Industrial Production Remains in Contraction

Although industrial production looked better on the headline basis after the Federal Reserve reported industrial production rising by 0.10% on a monthly basis during September, the annualized figures show an ongoing struggle for the sector. Concerns about the pace of the US economic recovery remain abundant, especially in light of the most recent data which showed a 13^thstraight monthly industrial contraction. Most of the gains in the monthly figure were driven by an uptick in nondurables production, namely thanks to the increasing prices of gas and oil. Nevertheless, the ongoing streak of declines on an annualized basis represent the longest period of non-recessionary declines in the sector ever recording, indicating a heightened potential for US growth metrics to slip in the coming quarters. The dollar is taking a breather on the session, contributing to gold prices retaking the $1260.00 level to the upside.

RBNZ May Be Forced to Accommodate Further

Following a weaker than anticipated report on consumer prices from New Zealand, speculation is rising that the Reserve Bank of New Zealand will be forced to cut rates once more before the end of 2016 in a bid to spur gains in consumer prices with a more accommodative monetary policy. According to the earlier report from Statistics New Zealand, annualized consumer prices slipped to 0.20% during the third quarter from 0.40% during the second quarter, highlighting the need for more aggressive action on the policy front. Nevertheless, policymakers remain largely unconcerned by the development, with the upside in the NZDUSD pair following the announcement underscoring this point. Annualized GDP growth remains among the highest in the developed world while unemployment is relatively stable at 5.10%, contributing to a more stable outlook for policy despite the rising potential for one more rate cut before the end of the year.