Inflation and Potential Political Crisis in France Headline European Markets

The Eurozone's flash August inflation reading is expected to stay in line with the ECB's target on Tuesday, as markets monitor the potential economic crisis in France.

Key Developments Affecting the Market

• Eurozone August inflation is expected to remain in line with the ECB's target of 2.0%.
• Debate continues within the ECB about when to make a final cut in interest rates for this cycle, but slow economic growth implies a risk that inflation might undershoot.
• The potential for a political crisis in France widens the yield gap and depresses risk appetite in Europe.

Euro Area Inflation in Line, Risk of Undershoot

according to a report released on Friday. Markets were expecting 2.2%, as the largest economy in Europe has been more buoyant amid expected increased government spending. Despite the reading aligning perfectly with the ECB's target, the meagre growth in the European economy has sparked concerns that inflation may fall short of the central bank's target, potentially returning the continent to the persistent slow-growth, slow-inflation scenario that preceded the pandemic. The ECB is projected to cut interest rates one more time during this cycle, with the timing still up for debate. However, persistent signs of inflation falling below target (such as France's August CPI of 0.8%, down from 0.9% the previous month and also below expectations by one decimal point) may change that.

Following the release of the German data, analysts adjusted their projections for August inflation in the Eurozone to remain unchanged at 2.0%, from expecting it to tick up to 2.1%. The consensus among analysts predicts inflation will remain, aligning with projections from the ECB as disclosed in the latest monetary policy meeting minutes. However, the minutes showed a persistent division about whether inflation will stay on course in the long term, which could lead to renewed talk of a rate cut after a pause in September. The impact of Trump's tariffs on trade between the EU and the US, as well as the timing of a potential resolution of the war in Ukraine, could impact when the ECB cuts rates again.

Risk of Government Collapse in France Worries Markets

Markets in Europe struggled to make headway last week after in his government on September 8 to support €44 billion in budget cuts. Three opposition parties said they would not back the vote, risking another cabinet collapse, with French bonds selling off in the aftermath of the announcement. The Prime Minister's gamble to garner sufficient political support to shore up the finances of Europe's second-largest economy risks triggering a new snap election. If the Prime Minister calls for an election, it could lead to ripple effects in the Eurozone, potentially widening bond spreads with other countries and weakening the euro.

EURUSD Gathering for a Breakout

The EURUSD could be forming a bullish pennant as the two 'autorader' trendlines converge and Bollinger bands contract. A breakout would encounter resistance at 1.1740, the high for August, before heading towards the year's high at 1.1800. Support can be found at the near-term swing low if the upper BB holds firm, which coincides with the lower BB at 1.1580, followed by the August low at 1.1410.

Source: SpreadEx | EURUSD