Euro Exchange Rates Suffer Deflation Shock, EUR/USD to Test 1.18

Inflation falls and euro outlook deteriorates

The eurozone has finally entered a period of deflation providing the decision makers at the European Central Bank (ECB) the clearest shot yet to introduce sovereign quantitative easing.

The expectation that such measures will be taken in 2015 has kept the euro exchange rate complex firmly on the back-foot for the past year.

Fresh losses have been seen in the euro dollar following the inflation statistics confirming to us that the broader downtrend remains firmly entrenched. We now see EUR/USD on the path to a test of 1.18.

The euro to pound exchange rate (EUR/GBP) meanwhile remains stable as UK economic news fails to inspire.

A preliminary Eurostat report says that Euro area annual inflation is expected to be -0.2% in December 2014, down from 0.3% in November.

Currency markets and economists had been forecasting a reading of -0.1%.

However, declines in the shared currency were kept limited by the core CPI figure which came in at 0.8%, as opposed to expectations for 0.6%.

Also protecting the currency from further selling pressure was German employment data which shows the Euro area’s biggest economy saw 27K more people come out of unemployment over December.

Nevertheless, the outlook for the euro exchange rate complex remains a challenge.

Dennis de Jong, managing director at UFX.com says:
 
“These really are desperate times for the eurozone with the monetary bloc finally slipping into deflation.

“Mario Draghi can’t afford to sit on his hands any longer and the introduction of a bond-buying quantitative easing programme later this month now looks increasingly likely.
 
“The political situation in Greece has the potential to cause serious harm to the Euro in the short term and with economies across Europe already performing poorly, the gloom is unlikely to lift anytime soon.”

Euro Dollar Outlook Deteriorates

Looking at the path ahead for the shared currency we see further losses against the US dollar are likely.

Lloyds Bank tell us:

“With the USD continuing to be supported by a trending oil market and flattening yield curve, we have seen the USD drift to new highs overnight and particularly EURUSD pushing through the 2010 lows and potential new breakout of the 6 year range. Next main supports not seen till the 1.1675/50 area.”

In the US, the ADP release for December will provide a heads-up on Friday’s employment report.

“We have pencilled in an increase of 245k for the ADP, but would note that this survey significantly underestimated last month’s 321k rise in official nonfarm payrolls,” say Lloyds.

The minutes of the December FOMC minutes will also be released, but are not expected to significantly change expectations about the outlook for monetary policy.