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As expected! High inflation cannot exist in a weak economy, and the Eurozone is clearly lagging behind the US. Therefore, consumer prices in the currency bloc should be moving toward the target faster than in the US. The drop in Spanish inflation to its lowest level in a year and the first decline in the German Consumer Price Index below the critical 2% mark since March 2021 serve as evidence of economic laws at work and reasons for selling EUR/USD.
Dynamics of Spanish Inflation
If the US recalls the 1970s, the Federal Reserve prematurely celebrated victory over high prices, they returned, and the US economy faced a double-dip recession. So why shouldn't the Eurozone recall the beginning of the 21st century? Back then, under Mario Draghi, the European Central Bank made Herculean efforts to combat deflation. The weakness of the economy prevented the CPI from making any significant growth. Neither the drop in interest rates to zero nor large-scale quantitative easing programs helped.
If the surge in inflation in 2021-2022 was linked to disruptions in supply chains due to the COVID-19 pandemic, and their recovery allowed prices to fall, then why not consider a return of deflationary thinking to Europe? The CPI falls significantly below the 2% target, and against the backdrop of high ECB rates, this will harm the bloc's economy. The ECB needs not just to lower borrowing costs in September but to accelerate the pace of monetary easing. This is already a story favoring the bears on EUR/USD.
Dynamics of European Inflation
Is it any wonder that Chief Economist Philip Lane is more confident that inflation will return to target due to a significant drop in wage growth in 2025-2026? But this man claimed a few days ago in Jackson Hole that the fight against inflation is ongoing and there are no guarantees of victory. How quickly the global economic and Forex landscape changes!
Before the releases of Spanish and German CPI data, the futures market expected two acts of ECB monetary easing in 2024, with a slight chance of a third. However, the slowdown in inflation, economic weakness, and the willingness to follow the Fed with its start of the monetary easing cycle in September could lead to more cuts. Where will EUR/USD head in this case? That's right, down!
The main currency pair might be supported by a weaker estimate of US GDP for the second quarter and the recovery of US stock indexes after the NVIDIA-related sell-offs. However, I don't think both bullish drivers will go hand in hand. The increasing chances of a recession will likely cause the S&P 500 to fall.
Technically, on the daily chart, EUR/USD continues to pull back to the uptrend. Only a rebound from the moving average followed by a return above 1.114 will allow us to return to buying. If prices remain below 1.115, it makes sense to continue adding to shorts formed from 1.118.
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