The ECB is expected to meet later this week to discuss forward guidance. Interest rates are expected to remaine the same. The meeting will be intensly viewed by market participants who are curious what President Lagarde next course of policy action will be. Consumer prices are expected to fall into negative territory, -0.2% in August, down from 0.4% in July, whilst core inflation is expected to fall to 0.4% in August, down from 1.2% in July. A negative inflation rate, deflation is a sign of a weakening economy led by consumer spending reduction.
These drops in inflation come against aggressive accomodative policies by the ECB and fiscal policies by the EU commission to stoke inflation and rev up economic growth. A rising EURO further complicates Lagarde’s job in attempting to achieve those targets as an expensive currency makes exports less competitive. During the first week of September, EUR/USD rose to 1.20, a level not seen since May 2018.
ECB council members have mixed opinions on the currency as some are admitting that it is a huge concern, some are saying that it just needs constant monitoring and is not problematic as of yet. Lastly some are more optimistic to say that EUR rise stemmed from positive news surrounding the €750 billion Next Generation EU recovery fund and thus shows that EUR was acutally undervalued against USD.
With the currency in mind, the ECB is expected to amend its macroeconomic inflation projection down from 0.8% in 2021 and 1.3% in 2022 to further reflect underlying economic and market conditions. If so, we can expect further easing which will possibly lead to further decline in sovereign yields.
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