Widening Gap Between European and US Inflation

on Jul 1, 2021
Updated: Dec 19, 2022

The CPI Flash Estimate report for the month of June shows European annual inflation coming down to 1.9% y/y from the previous 2% y/y. Inflation in Europe cools down while continuing to rise in the United States.

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The last day of the trading month brought one of the most interesting reports for euro traders – the CPI Flash Estimate for the month of June. This is a monthly release that comes out on the last business day of the month and presents the annualised inflation.

It showed that inflation cooled down in June, from 2% the previous month to 1.9%. While not significant, the decline is important when interpreted in the global context. More precisely, inflation is slowing in Europe and Japan, but accelerating in the United States.

The EUR/USD exchange rate immediately reacted to the report. It dropped from above 1.19 to a new monthly low, on traders betting that the Fed will act on rates earlier than the ECB due to the widening gap between the European and the United States inflation.

Details of the Inflation Report

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The ECB’s mandate focuses on delivering price stability. It defines price stability by keeping inflation below, but close to two percent. We may, therefore, say, that 1.9% is in line with the ECB’s view of price stability.

Across countries, there is little or no divergence in inflation. Germany and Spain lead with inflation above 2%, while France and Italy lag. Nevertheless, uniformity in inflation data is something that the ECB likes.

A breakdown of the inflation report in Europe reveals that energy prices account for most of it. The rally in the oil prices is seen as transitory by most central banks, thus expectations are for inflation to further decline in the future.

But the chart above shows the impact of oil prices on inflation. The 2021 rally in oil prices continues, with the WTI crude oil price, for instance, trading above $73. As long as oil remains bid, inflation has little or no chance to come down from the current levels.

All in all, this is good news for the ECB and bad news for euro bulls. The report suggests that the ECB gains time before removing the accommodative measures, while the Fed comes under increasing pressure.


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