Euro-Dollar Falls on Big Inflation Drop

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Euro exchange rates retreated following the release of Eurozone inflation data that verified market bets for a number of European Central Bank (ECB) rate cuts to take place in 2024.

The Euro to Dollar exchange rate extended its daily decline to 1.0910 after Eurostat said Eurozone inflation fell to 2.4% year-on-year in November, from 2.09% in October, putting it a mere few points away from the ECB's 2.0% target.

"The euro took a dive on Thursday, retreating from three-and-a-half month highs against the US dollar, as weaker-than-expected CPI numbers out of the Eurozone pressured the single currency," says Raffi Boyadjian, Lead Investment Analyst at XM.com.

ECB President Christine Lagarde and other members of the Governing Council are, however, more interested in core inflation, arguing that it will fall slower and mean it will be some time before inflation falls to the 2.0% target on a sustainable basis.

But this argument will look a little weaker today after Eurostat said Eurozone core CPI fell 0.5% month-on-month in November from +0.1% in October. Core CPI rose 3.6% y/y, but this was well below the 3.9% the market was expecting and sharply down on October's 4.2% reading.

"The Eurozone’s core CPI is falling even faster than market participants expected. Traders will be tempted to bring their expectations of the first rate cut forward," says Mathieu Savary, Chief European Strategist at BCA Research.

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This expectation repricing is reflected in a softer Euro-Dollar exchange rate at 1.09, half a per cent lower than where it started Thursday.

"The data boosted expectations that the European Central Bank will begin slashing rates sooner rather than later, with the latest market pricing suggesting that the Europeans may beat the Fed with the first rate cut of the cycle," says Boyadjian.

Eurozone inflation is now tracking at 2.65% in the fourth quarter, which is far below the 3.3% average estimate set out in the ECB's forecasts made in September.

"Markets are now beginning to price for an April cut, and the price action for EURUSD in the coming weeks will be partially driven by the rate cut timing from the ECB vis-a-vis that of the Federal Reserve," says Joe Tuckey, Head of FX Analysis at Argentex Group.

"Euro area: Service price inflation is also slowing down" - Commerzbank.

However, BCA's Savary cautions that rushing forward rate cut bets "would be a mistake. The ECB is too concerned by the tightness of the labour market, which implies later rather than sooner rate cuts."

Indeed, HSBC said this week it won't be until 2025 that the ECB will cut rates as wage settlements are likely to run at levels inconsistent with inflation falling back to 2.0% on a sustainable basis anytime soon.

The market is potentially at odds with the ECB as to when the first rate cut falls. If the ECB prevails and rate cuts aren't delivered until late 2024, at the earliest, then the Euro can recover as expectations readjust.

Christoph Weil, Senior Economist at Commerzbank, says it is too soon for the ECB to declare victory against inflation, given the strong rise in wages.

"The key factor for the rest of the year will be when companies pass on the recent sharp rise in labour costs to their customers. Weak demand suggests that this will happen later rather than sooner," says Weil.

Commerzbank looks for core inflation to stabilise well above the ECB's target of 2% by the second half of 2024, "as a result, we believe it is too early to talk about a victory over inflation. We continue to believe that the ECB will not begin to lower its key rates until the end of 2024."