Euro gains ground, German CPI inches upwards

The euro has posted strong gains on Thursday. EUR/USD is trading at 1.0749, up 0.57%.

German CPI ticks higher

German inflation came in at 8.7% y/y in January, up from 8.6% in December. On a monthly basis, CPI rose 1.0%, following a -0.8% reading in December. The report shows that German inflation remains high and it’s still too early to talk of a peak. The good news is that nasty double-digit inflation seems behind us, thanks in large part to lower energy prices due to a warm winter in Europe.

The ECB raised rates by 50 basis points last week, bringing the cash rate to 3.0%. The cash rate remains well below that of all other major central banks – the Fed’s rate, for example, is at 4.75%. ECB policy makers have noted that core inflation, which is a more reliable gauge than headline inflation, remains stickier than expected. The central bank meets next on Mar. 16 and the markets have priced in a 50-bp hike. What happens after March is uncertain. The ECB could take a pause in order to assess the impact of its tightening cycle or it could continue hiking, perhaps in modest increments of 25 bp, until there is a clear indication that core inflation is coming down.

ECB rate policy is primarily focused on taming inflation, but it must also keep an eye on the strength of the German economy, the largest in the eurozone. Recent data has been weak, which will make it harder for the ECB to deliver oversize rate hikes. German Industrial Production came in at -3.2% in December, GDP in Q4 contracted by 0.2%, retail sales for December slumped by 5.3% and Manufacturing PMI remains mired in contraction territory.

The Fed paraded four policy makers on Wednesday, each of whom drummed the message that the fall in inflation was welcome but the fight was not yet over. Fed member Williams said that a restrictive policy stance could last for a few years until inflation dropped to the target of 2%. The markets may be listening more closely to the Fed since the blowout employment report on Friday, but continue to underestimate the Fed’s end game. The markets have priced in a terminal rate of 4.6%, while the Fed has projected a terminal rate of 5.1%.

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EUR/USD Technical

• EUR/USD is testing resistance at 1.0758. Above, there is resistance at 1.0873
• 1.0714 and 1.0633 are providing support

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