We had an opportunity to ask Santa Zvaigzne-Sproge about the incoming EU CPI release. A slight uptick in Eurozone inflation is expected, but would the euro care about it on Thursday?

Inflation is one of many factors that may have an effect on the euro. Generally, higher inflation puts downward pressure on the domestic currency as its purchasing power diminishes. On the other hand, the ECB has stipulated that its fundamental goal is to reduce inflation via monetary tightening, which includes rising interest rates. Rising interest rates have the opposite effect – it pushes the domestic currency higher as the money becomes “more expensive” and less available.

If the reported EU CPI data is reported at the expected level of 8.6%, it may not have any additional effect on the euro

Another factor to remember is that markets tend to react not only to the absolute numbers of macroeconomic news (such as EU CPI) but also to the surprise compared to the expected data. This means that if the reported EU CPI data is reported at the expected level of 8.6%, it may not have any additional effect on the euro despite an uptick in inflation compared to the previous month.

This goes hand in hand with the opinion that in case a scenario is possible to come true, the markets may already reflect this scenario before the actual news comes out. In other words, by the time EU CPI is announced on Thursday, EUR/USD exchange rate may already reflect a slight increase in inflation from 8.5% to 8.6% – and therefore may not have a considerable effect on the euro once the news comes out.

As higher inflation may push the ECB to continue rising interest rates – and therefore eliminate the downward pressure on the euro – higher-than-expected CPI data may have a limited downward effect on the euro.

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Taking into consideration all of the above, the largest potential effect on the euro may have an unexpected decrease in inflation pushing the euro higher as it may indicate that the ECB’s monetary tightening is working, and the potential for a “soft landing” may be increasing.

Santa Zvaigzne-Sproge, CFA, Head of Investment Advice Department at Conotoxia Ltd. (Conotoxia investment service)

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