– EUR under pressure from ECB rate cut hopes
The EUR continue to trade just above 1.3050 as dovish ECB expectations outweigh some further compression in the Italian-German 10Y spread (330bps vs. 345bps Tuesday). The euro zone January core CPI slowed to 1.3% y/y and the flash estimate for the headline February CPI should show a slowing to 1.9% y/y later today. The ECB’s new staff projections due at next week’s policy announcement (7Mar) are likely to downgrade the outlook for price stability. Acknowledging recent tightening in financial conditions, our economists have revised their view and now expect at 25bp cut in the ECB’s refi rate either next week or in April. This suggests on-going downside risks for the EUR and our EURUSD long trade recommendation, established at 1.3180, with a stop-loss at 1.2980. However, we would argue that a refi rate cut would probably be least damaging for the EUR, as compared to other potential forms of easing such as cutting the deposit rate to negative. The ECB also faces the dilemma of diverging country growth performances within the euro zone where Germany has been a clear outperformer – we expect a solid 1.2% m/m gain in German January retail sales today. We do not believe that Italian election is a game-changer for the EUR and maintain a positive medium-term outlook for the currency.
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BNP Paribas