Business As Usual For EUR and JPY

All eyes were on Euro inflation numbers this morning, and consensus from the outset was that data in line with market expectations would not necessarily be weak enough to make the ECB act next week. Even expectations for a rebound would also suggest that the ECB would have some near term breathing space. However, if there were a sign that deflationary pressures were very much in place then this would have the potential to put pressure on the ECB to act – allowing investors to apply new pressures on the 18-member single currency. The belief that if the ECB and BoJ happen to adjust their monetary policies this would increase market volatility, creating risks and more opportunities for investors, as opposed to being confined to narrow trading ranges. It seems the market did not get its wish just yet – probably have to wait for Friday’s NFP report.

The Euro-zones annual rate of inflation picked up in April, but by less than the market had expected. The headline print came in at +0.7% on the year, a touch below the +0.8% consensus expectations. Prices were certainly a pickup from the +0.5% rate of inflation recorded in the 12-months to March, but well below the ECB’s target of just under +2%. This month marks the seventh consecutive month that the inflation rate has been below +1%. Last October, when there was a sharp drop in prices from +1.1% to +0.7%, Draghi and company quickly responded with a cut in its benchmark interest rate. Since then, the ECB has done little other than pledge that it will act decisively if inflation happens to veer too far away from its target. Nonetheless, the case for action by the ECB is not clear-cut just yet. Some of the slowdown in the inflation is down to weaker global prices for energy (dropped -1.2% from a year ago) – obviously a situation that the ECB has little control. But prices for other goods and products rose at a slower pace (food, alcohol and tobacco +0.7% on the year compared to +1% in March). With service prices rising more strongly in response to higher demand at Easter had core-inflation pick up to +1.6% from +1.1%.

The immediate impact on the EUR was limiting. The single currency briefly slipped against the dollar, hitting a three week low of €1.3771 before quickly bouncing back to trade +0.1% higher on the day, north of €1.3820. Although slower than expected inflation will encourage expectations of ECB easing, many were already looking fro a lower print especially after some sluggish German price data earlier this week. Despite this morning’s data not necessarily being weak enough to make an ECB easing likely next week, but it should still keep markets wary of adding longs EUR positions into the event. Market consensus favors a June reaction from Draghi and company.

The BoJ’s closely watched semi-annual forecast on Japanese inflation and growth was this morning’s other major event risk. Everything ended up being mostly in line with expectations. The BoJ projected that prices will hit its +2% inflation target and stay there without the need of further market stimulus. Nevertheless, they have lowered their forecast for economic growth. Japanese policy makers have some tough decisions to make, despite further monetary easing not being required on the inflation side, it seems to be necessary in terms of Japanese economic growth.

Earlier, the BoJ kept intact its monetary policy stance and unanimously decided to maintain its QE commitment at ¥60-¥70 Trillion a year. In his post conference appearance, Governor Kuroda from the BoJ insists that the Japanese economy is recovering “moderately and that domestic demand is remaining solid.” For some time the yen’s direction has been determined by swings in risk appetite. With JPY widely sold to fund “carry” trades, it has typically rallied during bouts of risk aversion or fallen during good times. After months of sideways trading and a sharp drop in option implied vols, JPY shorts have aggressively been pared back and the close “negative” relationship with the Nikkei seems to have broken down. There is a market belief that the JPY might start to reflect the weakness of the Nikkei and actually head south along with domestic equity benchmark prices. Investors will now be looking to today’s FOMC decision and Friday’s NFP headline print for inspiration. With Japanese exports away from the market due to the Golden week holidays, combined with any optimism from US fundamentals could manage to push USD/JPY to break out of its confined trading range.

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