FX - EUR/USD: Trading the Euro-Zone Consumer Price Estimate

Trading the News: Euro-Zone Consumer Price Index Estimate

What’s Expected:

Time of release: 04/29/2011 9:00 GMT, 5:00 EST

Primary Pair Impact: EURUSD

Expected: 2.7%

Previous: 2.6%

DailyFX Forecast: 2.6% to 2.7%

Why Is This Event Important:

The flash estimate for European inflation is projected to increase at an annualized pace of 2.7% in April, which would be the fastest pace of growth since October 2008, and the rise in consumer prices could spark a bullish reaction in the single-currency as investors speculate the European Central Bank to normalize monetary policy further in the coming months. As the Governing Council toughens its stance against inflation, market participants are see the benchmark interest rate increasing by 75bp in the next 12-months according to Credit Suisse overnight index swaps, and the EUR/USD may continue to work its way towards 1.5000 as it maintains the upward trend from earlier this year. However, as ECB President Jean-Claude Trichet softens his hawkish tone for monetary policy, we may need an even higher rate of inflation to fuel the rally in the single-currency, and the market reaction to the CPI estimate could certainly be short-lived as market participation thins ahead of the weekend.

Recent Economic Developments

The Upside

The Downside

As the economic recovery in Europe gathers pace, with the region continuing to benefit from the expansion in global trade, businesses may see scope to pass on higher costs onto consumers as they cope with rising input prices. However, as consumer confidence wanes, the slowdown in household spending could lead firms to absorb higher costs, and businesses across the region may keep a lid on consumer prices in an effort to drive domestic demands. A steady rate of inflation could certainly spark a near-term correction in the EUR/USD as investors scale back speculation for higher borrowing costs, and we may see the pair retrace the advance from earlier this week as the near-term rally remains overbought.

Potential Price Targets For The Release

How To Trade This Event Risk

Projections for a faster pace of inflation certainly reinforces a bullish outlook for the single-currency, and the market reaction to the CPI estimate could pave the way for a long euro trade as it maintains the upward trend from earlier this year. Therefore, if price growth expands 2.7% or greater in April, we will need to see a green, five-minute candle following the release to establish a buy entry on two-lots of EUR/USD. Once these conditions are fulfilled, we will set the initial stop at the nearby swing low or a reasonable distance from the entry, and this risk will generate our first objective. The second target will be based on discretion, and we will move the stop on the second lot to cost once the first-trade reaches its mark in order to lock-in our winnings.

On the other hand, the tepid recovery in the European labor market paired with the slower pace of private sector consumption could lead businesses to absorb higher input costs, and an uneventful CPI report could bear down on the exchange rate as investors scale back speculation for another rate hike in the first-half of the year. As a result, if the headline reading surprising holds steady at 2.6% or unexpectedly cools from the previous month, we will carry out the same setup for a short euro-dollar trade as the long position laid out above, just in the opposite direction.

Impact that the Euro-Zone Consumer Price Estimate has had on EUR during the last month

March 2011 Euro-Zone Consumer Price Estimate

The headline reading for euro-area inflation increased at an annualized pace of 2.6% in March to mark the fastest pace of growth since October 2008, and the European Central Bank is widely expected to lift the benchmark interest rate off the record-low in order to stem the acceleration in price growth. Investors are pricing a 100 percent chance for a 25bp rate hike in April as consumer prices exceed the ECB’s 2% target for inflation, and the central bank may turn increasingly hawkish over the coming months as the economic recovery in Europe gathers pace. However, the Governing Council may have little choice but to delay its exit strategy further as the governments operating under the fixed-exchange rate system struggle to manage their public finances, and fears surrounding the sovereign debt crisis may continue to bear down on market sentiment as the risk for contagion intensifies. Nevertheless, the euro extended the rebound from earlier this month following the faster pace of inflation, but the rally was certainly short-lived as the exchange rate fell back from a high of 1.4232 to end the day at 1.4157.

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To discuss this report contact David Song, Currency Analyst: dsong@dailyfx.com