Thought of the day
01.08 - Euro strength confounds skeptics
The euro has appreciated significantly against the USD dollar over the past month, rising from 1.13 to 1.18. At first glance, Eurozone CPI data for July does not appear to support that rally. Headline inflation remained stubbornly low, unchanged from June at 1.3% year-on-year and down from a four-year peak of 2% in February.
But despite the headline figure, recent data have provided plenty to support our view that the European Central Bank will continue to prepare the market for a reduction in the pace of quantitative easing.
- Core inflation: The core rate of CPI – which strips out food and energy – rose to 1.2% from 1.1%. This is now only 0.1 percentage points below the average since 2003. With inflation so close to its historical norm, it becomes harder for the ECB to justify the current pace of quantitative easing.
- Unemployment: While wage growth remains subdued – Eurozone hourly labor costs increased by just 1.5% year-on-year in the first quarter – unemployment declined to an eight-year low of 9.1% in June. A tightening labor market should be taken as an encouraging sign by the ECB.
- Domestic demand: Consumer spending is rising. Retail sales for Germany, Europe's largest economy, climbed 1.1% month-on-month in July, the fastest rate in eight months.
So we believe the Eurozone economic recovery is continuing to mature, and the data should remain supportive of both the euro and Eurozone equities. We expect EURUSD to rise to 1.20 over 12 months, and we are overweight Eurozone stocks versus UK equities within Europe.