The latest business PMI surveys for the euro zone will hit markets early on Monday, starting with the French figures at 08:15 GMT. Forecasts suggest that the Eurozone economy has lost further steam thanks to Omicron’s restrictions. Overall, economic growth remains sluggish and contrary to market expectations, the European Central Bank does not appear ready to raise rates this year, leaving the euro vulnerable.
New year, same old blues
The Eurozone recovery was rather disappointing. Economic growth remains stuck at a slow speed with covid restrictions which have recently returned to several countries. The labor market is not impressive either since the unemployment rate is still high at 7.2%.
On the other hand, inflation has soared dramatically. Consumer prices are rising at the fastest pace in decades, sparking speculation that the ECB will soon be forced to raise interest rates. Money markets are currently forecasting rate hikes of 15 basis points for this year. However, this seems unrealistic.
The main difference between the ECB and the Fed is wage growth. While US wages have recovered in a labor market close to full employment, the same has not been the case in Europe. This means there is little “organic” inflation, so price pressures could ease once supply chains come back online and energy prices stabilize. .
ECB President Lagarde made the same point this week, when she said “The economic recovery cycle in the United States is ahead of that in Europe, so we have every reason not to act as quickly and ruthlessly as one might imagine with the Fed”.
More bad news
Future business surveys should confirm this narrative. The manufacturing and services indexes are expected to fall a little further in January, which would indicate that economic growth is slowing as the measures against Omicron begin to bite.
On the bright side, such figures would imply that growth remains at least positive, so the economy likely absorbed the latest round of restrictions with less damage than previous waves.
The euro looks vulnerable
On the foreign exchange market, the first reaction of the euro will depend on possible surprises in the PMI figures compared to the forecasts. Looking technically at the euro/dollar, a disappointment could see the pair drop to retest the 1.1270 zone. On the upside, preliminary resistance may be seen around 1.1370.
Overall, the next few months could be difficult for the euro. The obvious risk is that the ECB disappoints market expectations. The European economy just doesn’t look strong enough to sustain higher rates and weak wage growth means inflation may subside on its own in the future.
Another puzzle for the ECB is how the bond market might react to higher rates. The European bond market has grown accustomed to extraordinary levels of stimulus, so a pullback would risk a sharp rise in yields, especially for highly indebted economies like Italy. Such a spike could dampen the entire recovery, so the ECB cannot brake too hard.
Political risk is also back on the radar. The French presidential election in April is approaching and President Macron will have to face opponents skeptical about the pursuit of European integration.
All of this suggests that the risks surrounding the euro/dollar remain tilted to the downside for now. But that could be a different story in the second half. If the European labor market does eventually pick up and this also coincides with the “peak inflation” in the US, that could be enough to turn the tide for the pair. Buckle up, this could be a stormy year.