Eurozone CPI preview: Traders need to look beyond likely short-term inflation bump

This week sees eurozone inflation data come to the forefront, as traders gradually return to their desks in anticipation of an exciting year ahead for financial markets. The prospect of a disinflationary driven policy of monetary easing from some of the biggest central banks does help explain the optimism that has seen equity markets push into long-term highs. However, there are some concerns that we may have seen expectations run too far given the current pricing for a whopping six rate cuts from the Federal Reserve. Worryingly, this comes in stark contrast to the latest dot plot which signalled a plan to cut just three-times. Nonetheless, things have appeared less complicated in the eurozone, with inflation seemingly plotting a swift return to target. Meanwhile, continued economic concerns put pressure on the ECB to cut rates before long.

December saw Christine Lagarde adopt a relatively hawkish stance despite the decline into 2.4% inflation, with the ECB Governor seeking to calm expectations of a dramatic monetary pivot in 2024. On the wider economic front, this week has already kicked off with an 18^th consecutive contraction figure for the manufacturing PMI (44.4).

Nonetheless, inflation remains the key metric to follow, and things could become a little more confusing for markets this month. The chart below highlights why markets are looking for a sharp jump in inflation this time around, with Trading Economics and forexfactory both predicting a 3% figure for headline CPI (up from 2.4%). This has more to do with the nature of following an annual figure than the experience of prices in December per se. As we strip out last year’s -0.36% December figure, those so-called ‘base effects’ mean we are likely to see the year-on-year inflation figure rise. Another -0.6% figure like that seen last month would be required to maintain the downward trend seen over recent months. However, the benefits from a slump in energy prices in November are likely to be less prominent this time around, meaning that a more normal monthly figure is expected for December. Markets predict a monthly figure of 0.1%, which would drive up the annual number as it replaces the -0.36% reading from last year. While this short-term period of higher or sideways inflation is likely to extend into next month when the -0.2% figure is replaced, we will likely see dramatic disinflation once the February (0.8%) and March (0.9%) numbers drop out. The big question is whether markets will be able to look beyond this short-term jump in eurozone CPI to look through towards the likely slump back to 2% within the following months.

While markets will undoubtedly focus on the potential reversal in the trajectory of headline inflation, the strong likeliness that we will see the 2% target hit by March/April does bring greater importance for the core figure. Markets are looking for this steady disinflation trend to continue apace, although estimates appear to be relatively well spread in terms of just how sharp that drop might be. Of the top four forecasters ranked on the Refinitiv Eikon platform, all four took on different predictions. Nonetheless, the most common prediction seen from the top 10 economists was a decline to 3.4%. Should we see a fresh decline for core inflation, it would help provide confidence that underlying prices remain on the right trajectory. With the December 2022 figure of 0.58% being stripped out, it does look highly likely that we continue to see price pressures abate. With the past seven-months inflation annualizing to 1.09%, the recent path puts core inflation on track to tumble below target once the April figure is announced (early-May).

EURUSD technical analysis

The EURUSD pair has been heading lower in early trade this week, falling back after a year-end surge that reached a fresh four-month high. However, a rise in the eurozone inflation figure could provide a temporary risk-off dollar surge if it comes to fruition. That points towards a possible short-term extension of this pullback, with the 1.082 to 1.088 Fibonacci zone coming into view (76.4 to 61.8%). Nonetheless, the ability to look beyond any short-term, base effect driven effect means that there is a strong chance we soon see price turn upwards once again to carry on this recent bullish trend. A break below 1.07238 would be required to bring an end to this three-month uptrend.