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Inflation levels for Eurozone increased to a three year high. The December Consumer Price Index (CPI) surged to 1.1% over the period of twelve months according to the European Union’s statistics office, Eurostat. The result surprised the markets not only for being much higher than the previous month’s 0.6%, but also because analysts were expecting an increase of 1%.

The last time that the inflation rate was at the level of 1.1% was back in September 2013, and the higher-than-expected result is a sign that inflation is moving closer to the European Central Bank’s (ECB) target of just under 2%. ECB President Mario Draghi said that the Bank estimates the target to be achieved by 2019.

The main reasons for December’s inflation increase were the rise of energy prices over the twelve-month period by 2.6% as a result of the Organisation of Petroleum Exporting Countries’ (OPEC) agreement to reduce crude oil production. Alcohol and tobacco prices increased by 1.2% during 2016 while fees for services were up by the same percentage.

The inflation increasemay reduce concerns by the markets that the Eurozone economy is on its way to deflation and therefore prevent economic growth. However, the CPI index after excluding energy and food prices (the core rate) managed to show an increase by only 0.9% in comparison to the previous month’s 0.8%. And this is why there are still worries that the increase in inflation might only be temporary.

A separate report released by IHS Markit based on data provided by business executives of manufacturing and services companies showed that the index increased to 54.4 during December compared to previous month’s 53.9. Analysts were expecting no change to the index, but instead the report indicates that the economy grew at its fastest rate for more than five years. The same report also mentioned that the level of pricing for both goods and services increased at the steepest pace since 2011.

Chris Williamson, Chief Business Economist at HIS Markit said that “For the moment, companies are brushing off political worries, with optimism among service sector companies – who will arguably be the most affected by any political turmoil – reviving to one of the highest levels seen for over five years.”

The EUR/USD reacted to the unexpectedly positive Eurozone inflation data on Wednesday by increasing by 0.8%. The currency pair continued the following trading session with additional gains of 1% and reached 1.06033.

Given that the Eurozone inflation rate has been higher than 1% for the first time since September 2013, it has renewed some requests for an interest rate increase. Market analysts however are of the opinion that the economy is not as strong yet to allow for such decision. They also believe that the ECB should continue with its Quantitative Easing (QE) programme of purchasing €80 billion worth of bonds each month until the end of February and any trims afterwards to not go beneath the pre-agreed €60 billion per month until the end of the year.

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