Euro Holds Its Ground Despite Signs of Deflation

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Market Drivers for June 3 2014

RBA maintains neutral bias

EZ inflation drop to 0.5% from 0.7% but labor improves

Nikkei 0.66% Europe -.05%

Oil $102/bbl

Gold $1246/oz.

Europe and Asia:

AUD Retail Sales 0.2% vs. 0.3%

AUD RBA rates unchanged at 2.5%

EZ CPI 0.5% vs 0.7%

EZ Unemployment 11.7% vs. 11.8%K

North America:

USD Factory Orders 10:00 AM

The euro remained relatively steady in morning European dealing trading on either side of the 1.3600 barrier as the weaker than expected EZ CPI data was offset by the better readings on the labor front. With only a few days to go ahead of the key ECB meeting that markets appear to have found equilibrium as traders await the policy announcements from EZ monetary authorities.

EZ CPI printed at 0.5% versus 0.7% eyed as deflationary forces continued in the region with prices for clothing and food remaining very low at 0.1% versus 0.7% eyed. Although energy inflation rose from -1,2% to 0.0% services inflation slowed to 1.1% from 1.6% the month prior.

Mr. Draghi’s argument that much of the deflationary pressures in the EZ were due to energy price declines has clearly been proven wrong by today’s report which shows a deep and persistent downward pressure on prices across the board. The news virtually assures that the ECB will cut both the refi and the deposit rates at this Thursday’s governing council meeting.

However, with much of that policy action priced in, the EUR/USD saw very little reaction to the news. Indeed the pair rebounded slightly on short covering as EZ Unemployment decreased to 11.7% from 11.8% the month prior. While some analysts noted acerbically that this was the slowest job recovery in the world, it nevertheless is a tangible sign of progress in the region and may therefore introduce a note of caution to some of ECB’s more aggressive monetary plans. For now the euro remains in narrow band around the 1.3600 level as traders are content to square up positions ahead of the ECB meeting this Thursday.

In Australia the RBA left rates unchanged as expected and generally repeated much of it comments from the month prior. The central bank noted that the economy remains in a moderate state of growth with construction still expanding strongly but house prices moderating. The central bank made its obligatory nod to the high exchange rate of the Aussie but did not signal that it would take any policy steps to remedy the matter.Overall the RBA stressed that rates will likely remain stable for a considerable period of time and that was the primary takeaway of the market which rallied Aussie in relief that the RBA maintained its neutral posture. The pair remains in a broad 9200-9300 range and is likely to remain within those bounds until US NFPs this Friday.

In North America today the calendar is very light, but the dollar is receiving a boost from slightly higher US Treasury yields which have now climbed above the 2.50% level. That has helped to rally USD/JPY which is now within a whisker of the 102.50 level as it continues to rally of the recent lows at 101.50. The 102.50 has proven to be stiff resistance in the past, but if US rates continue to rise the pair could push towards 103.00 as the week progresses.

Boris Schlossberg
Managing Director

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