MUFG’s Lee Hardman notes that softer Euro-zone inflation has pushed EUR/USD below support at 1.1400, with yields falling and markets less confident of another ECB rate hike. The ECB’s “milder” scenario now looks more likely, reducing pressure to tighten further. Weaker cyclical momentum and lower yields are seen weighing on the Euro in the near term.

Softer CPI and yields pressure Euro

"The euro has continued to trade at weaker levels overnight after the release of much softer euro-zone inflation data reinforced downward momentum. It has resulted in EUR/USD and EUR/GBP breaking below support from the bottom of their recent trading ranges at 1.1400 and 0.8600 respectively. The latest euro-zone CPI report for June revealed that headline and core slowed more than expected to 2.8% and 2.4%."

"When taken together with lower energy prices as well, the euro-zone economy appears to be more closely aligned with the ECB’s “milder” scenario. The ECB staff projections from June revealed that headline inflation was expected to be at 3.2% in Q2 in both the baseline and mild scenarios, and core inflation at 2.4%. The latest favourable developments will dampen pressure on the ECB to tighten monetary policy further."

"ECB Chief Economist Philip Lane has recently cited concerns over second round inflation effects and indicated that their estimate of the top of the range of their neutral policy rate has been raised by 25bps to 2.50%. As a result, we believe it is too soon to drop our call for a September hike although acknowledge that there is higher risk now that rates will be left on hold through the rest of this year. The recent drop in euro-zone yields and softer cyclical growth momentum in the euro-zone are contributing to a weaker euro in the near-term."

"After hitting a peak at 2.83% on 18th June, the euro-zone 2-year government bond yield has fallen by around just over 30bps. A much bigger drop in yields than in the UK and Us rate markets over the same period."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor.)