The Euro-Dollar Rate Spikes after Manufacturing Sector Stabilises but ECB Minutes See Gains Fade

Image © European Union 2018 - European Parliament, Reproduced Under CC Licensing.

- EUR spikes after IHS Markit PMIs point to economic stabilisation.

- French manufacturers return to growth, German industry steadies.

- But the PMI numbers still point to "feeble" growth, economists say.

- And will be unlikely to deter ECB from adding stimulus next month.

- ECB minutes suggest the cavalry is saddling up, weighing on EUR.

The Euro was on its front foot and advancing strongly during early trading Thursday after IHS Markit PMI surveys showed the continent's beleaguered manufacturing sector stabilising in August, but gains were quick to fade after the European Central Bank (ECB) entered the fold. 

Thursday's Eurozone manufacturing PMI came in at 47.0, up from 46.5 previously and ahead of the consensus for a reading of 46.3. This is a two-month high and the largest one-month gain for the index since December 2017.

Gains came after the French manufacturing sector returned to growth this month, with the PMI index rising above the 50.0 no-change threshold to come in at 51.0 on the nose. The German PMI edged up from 43.2 to 43.6, although that number still suggests an ongoing industrial recession.

Surveys of purchasing managers in the services sector returned even more improved results, with both German and French services sectors continuing to expand. Momentum in the Frech sector gathered pace in August and although it wained in Germany, both saw services output growth rather than contract. 

"Small wins should be celebrated. A small uptick in eurozone's August PMIs from 51.5 to 51.8 is somewhat a relief today as analysts had expected a further slide. If nothing else, at least it indicates that the economy is unlikely to have slipped into negative growth halfway through the third quarter," says Bert Colijn, an economist at ING. 

The French and German economies account for around half of Eurozone output so when figures from one or the other strengthen it tends to bode well for the wider bloc, which has been under pressure in recent months due to damage from the U.S. trade war with China and uncertainty over the Brexit process. 

Europe's single currency spiked in response to the figures, which suggest the Eurozone downturn moderated this month. But economists say they still leave the bloc growing at a "feeble" pace and are unlikely to deter the European Central Bank from providing stimulus to the economy next month. Minutes from the ECB's July policy meeting subsequently confirmed as much on Thursday, leading the Euro's gains to quickly melt away.

"The small rise in the euro-zone Composite PMI in August still leaves it consistent with feeble GDP growth this quarter," says Melanie Debono at Capital Economics. "We still expect the ECB to cut its deposit rate by 10bps in September and to announce a fresh round of QE in October, but the chance that it will announce both measures in September has risen."

Above: Euro-to-Dollar rate shown at hourly intervals, alongside EUR/GBP rate (orange line, left axis).

"The rebound in the Euro-area PMIs was mildly positive news, but the details remain worrying. The Euro-area economy is too weak to generate meaningful inflation pressures, which means the ECB needs to do more," says Jan von Gerich, an economist at Nordea Markets. 

Expectations of monetary support from the ECB have mounted in recent months as the outlook for the Eurozone economy has gotten "worse and worse", in the words of ECB president Mario Draghi, which is undermining an already-insufficient inflation pulse across the block.

The ECB needs inflation to be at the target of "close to, but below 2%", although the core consumer price index has not been above 1.3% at all since the bank began its quantitative easing program in 2015. Headline inflation has been stuck below the ECB’s 2% target ever since November 2018 when oil prices began reversing earlier gains.

And if not for volatility in oil prices, the headline rate might not have seen the target level for a number of years. Meanwhile, Eurozone GDP growth fell from 0.4% to 0.2% in the second quarter, while the German economy contracted for a second time inside the last year.  

"We are inclined to believe that the ECB will double-down with both rate cuts and more QE next month, a forecast that is supported by recent comments from ECB officials," says Claus Vistesen, chief Eurozone economist at Pantheon Macroeconomics.

Changes in rates are normally only made in response to movements in inflation, which is sensitive to GDP growth, but impact currencies because capital flows tend to move in the direction of the most advantageous or improving returns. 

Those flows tend to move in the direction of the most advantageous or improving returns, with a threat of lower rates normally seeing investors driven out of and deterred away from a currency.  

"We are still wary of adding to our EUR short position below 1.1100 until we're clear of Powell. If there is going to be a big ECB "shock" in September, the decision making process on how to deliver it will probably go right down to the wire," says Stephen Gallo, European head of FX strategy at BMO Capital Markets. "A "core" short position in the pair overall is by far one of our most-loved exposures in FX."

Above: Euro-to-Dollar rate shown at daily intervals, alongside EUR/GBP rate (orange line, left axis).

"The Eurozone PMI outcome takes a bit of pressure of EUR/USD, which has been stuck in a minuscule 50-tick range this week and doesn't look much like breaking free. We get the ECB meeting ‘account' later, amid ongoing anticipation of September easing, and hope that something will be done with fiscal policy. With no Brexit news, we still like shorts in EUR/JPY (or GBP/JPY for that matter)," says Kit Juckes, chief FX strategist at Societe Generale.

The Eurozone's latest economic woes have roots in Germany, particularly the industrial sector that has been driven into recession by a global car market that's unravelling. Car manufacturers are a cornerstone of German industry, but they bet big on the luxury car market in China during recent years, which is imploding due to the trade war.

Chinese firms sell more than $550 bn of goods to American companies and consumers each year but these products are becoming less attractive because around $250 bn of them now incur a 25% tariff charge when they enter the U.S. Most of the other $300 bn of goods not yet subject to a tariff are now due to incur levies between September 01 and December 15. One of the effects of this policy has been to hurt demand for German cars in China. 

German car firms, already simultaneously coping with costly new regulation from Brussels, also now face losing access to the UK market. The Brexiteering UK economy is the largest of all global markets for German cars, with around 14% of all cars made in the central European country being shipped to the UK. Only now, an increasingly acrimonious divorce is widely seen as raising the risk of a 'no deal' Brexit at the end of October 31. That could see a 10% tariff applied to cars imported from Germany. 

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