Date: 01 Aug 2018

While the market awaits tonight’s decision from the Federal Reserve Open Market Committee (FOMC), yesterday’s euro zone data may have given the European Central Bank (ECB) something to ponder. Second quarter euro zone GDP growth disappointed somewhat with a 0.3 per cent quarter-on-quarter (q/q) rise, down from Q1’s 0.4 per cent print and in marked contrast to the pace of 0.7 per cent growth q/q seen in the later part of 2017. The ECB will no doubt wish to characterise the current deceleration in euro zone GDP growth as temporary but the risk is the market decides something more fundamental is occurring. At the same time euro zone core inflation, excluding energy, unprocessed food, alcohol and tobacco, rose 1.1 per cent in July up from June’s 0.9 per cent reading. Headline inflation, remembering the ECB’s target for inflation is close to but below 2 per cent, was 2.1 per cent in July up from June’s 2 per cent. If inflation keeps creeping up the ECB might feel it has to act (which would initially mean preparing markets for a move before the end of summer 2019) but if euro zone GDP growth continues to underwhelm that might make the ECB hesitate. But what has any of this got to do with Wednesday’s FOMC meeting? In truth, markets are expecting little from tonight’s decision. No material changes to the FOMC statement are expected but, given last Friday’s Q2 US GDP 4.1 per cent print and ahead of this Friday’s jobs data, the Fed will likely comment on the apparent robustness of the US economy and acknowledge that US inflation seems to be returning towards its 2 per cent target. The bottom line is that, with markets seemingly looking for a September US hike, the shock would be if the FOMC comes over as a little dovish. That would likely hit the USD. But if the FOMC stays ‘on message’ the currency market can then look ahead to Friday’s US jobs data while continuing to wonder what the current spate of euro zone data implies for the ECB. Perhaps, with that latter point in mind, if the FOMC meeting outcome ends up being as uneventful as markets seem to expect, the immediate arguments for further euro gains versus the USD (EURUSD) then become harder to make.

by Neal Kimberley, External Currency Analyst.