Euro Climbs on German Inflation Surprise

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The Euro was a clear outperformer at the start of the new month as it responded to another leap higher in Germany bond yields as investors react to surprisingly strong inflation readings.

German bonds fell and their yield rose as investors priced in higher European Central Bank (ECB) interest rates following the release of hotter-than-expected CPI inflation data in Germany.

German CPI rose 0.8% month-on-month in February said Destatis, exceeding expectations for a reading of 0.6%. In the year to February inflation rose 8.7%, unchanged on January but beating estimates for 5.8%.

The German data followed similar unexpectedly strong outcomes in Spain and France the day earlier and points to a robust Eurozone-wide print on Thursday.

The data prompted investors to raise expectations for the number and size of incoming ECB rate hikes, which in turn pushed regional government bond yields higher. "Markets pencilling in a higher peak in ECB borrowing costs at around 4% from recent estimates closer to 3.5% also is putting a tailwind on the euro," says Joe Manimbo, Senior Foreign Exchange Analyst at Convera.

Following the data, the German two-year bond yield rose to its highest level since 2008 at 3.18%, outstripping advances in U.S. and UK counterparts, pulling the Euro higher against the Dollar and Pound as a result.

"The German 2yr has been on a parabolic ride for several months now but lately has pushed higher at an explosive rate finally breaching 3.2% overnight. This is pulling EUR/USD off the lows and preventing the pair from cracking the 1.0500 support level," says W. Brad Bechtel, an analyst Jefferies.

Above: Germany's two-year bond yields have surged to levels last seen in 2008.

The Euro to Dollar exchange rate rose a percent to 1.0683 on March 01, with the Euro to Pound exchange rate climbing to 0.8850. (If you are looking to protect or boost your international payment budget you could consider securing today's rate for use in the future, or set an order for your ideal rate when it is achieved, more information can be found here.)

Rising bond yields incentivise Eurozone-based investors to repatriate capital into the Eurozone economy as they can now expect greater returns on holding bonds.

This reverses an outflow that has been in place during the years that saw the ECB cut Eurozone interest rates to the bone as they fought to keep growth elevated.

Underscoring the trend in yields was ECB Governing Council member and head of the Bundesbank, Joachim Nagel, who said midweek that further "significant" tightening may be needed beyond March and there were risks of an early slowdown in the rate hiking cycle.

The Euro's strength will also be reflecting unexpected news that China's factory sector saw a sharp rebound in February, raising the prospect of a boost in the Eurozone's high-value exports to China.

China's PMI read at 52.6 in February, up from 50.1 in January, which was the strongest growth in the series seen since April 2012, said China's National Bureau of Statistics.

The services sector PMI read at 56.3, up from 54.4 and ahead of expectations at 55.0.

The Caixin PMI read at 51.6, up from 49.2 and ahead of expectations for 50.2.

China's economy is recovering faster than economists had expected, which boosts pro-growth currencies and penalises safe-haven names such as the Dollar. "Throw in signs of China's economy making a strong comeback from its worst year in decades and it was enough to stoke risk appetite that depress demand for the dollar as a safe haven," says Manimbo.