Euro Boosted by Hotter Than Expected Spanish Inflation

January 30, 2023
  • U.S. yields are creeping higher as an eventful week begins; the two-day FOMC meeting begins tomorrow and will end Wednesday with an expected 25 bp hike; we get some key January survey readings this week
  • Spain inflation ran hot in January; ECB tightening expectations have picked up as a result; Germany reported soft Q4 GDP data; Spain reported firm December retail sales; U.K. Prime Minister Sunak said he will not raise taxes to fund pay increases for workers in the National Health Service; meanwhile , BOE tightening will continue
  • BOJ Governor Kuroda said the bank will maintain its 2% inflation target and continue monetary easing; New Zealand reported soft December trade data

The dollar is steady as a very eventful week begins. DXY is flat near 101.90 after two straight up days. After making a new cycle low last week near 101.504, DXY is on track to test the May low near 101.297. The euro is trading higher near $1.09 after higher than expected Spanish inflation was reported. A break above last week’s marginal new cycle high near $1.0930 would set up a test of the March high near $1.1185. Sterling is trading flat near $1.2385 and is likely to continue underperforming due to the negative fundamental backdrop despite expected BOE tightening (see below). USD/JPY is trading higher back above 130 as BOJ Governor Kuroda shows no signs of pivoting (see below). China markets reopened after being closed all week for the Lunar New Year holiday. While we believe that the current dollar weakness is overdone, we continue to respect the price action. Until a more hawkish Fed narrative emerges, the dollar is likely to remain vulnerable. Perhaps this week’s FOMC will provide a spark.


U.S. yields are creeping higher as an eventful week begins. The Fed, ECB, and BOE are all expected to hike rates, while we get a slew of key jobs market data from the U.S. and CPI readings from the eurozone. The 2-year yield is trading near 4.24%, up from the January low near 4.03%, while the 10-year yield is trading near 3.56%, up from the January low near 3.32%. Inflation measures continue to decelerate. However, headline PCE inflation of 5.0% y/y in December is still running more than double the Fed’s 2% target. As we’ve said many times before, getting inflation down from 8% to 4% is the easy part; getting it from 4% to 2% is the hard part and that’s what markets continue to miss. The Fed needs to continue reminding the markets that the road ahead remains difficult and full of surprises. Indeed, Spain’s unexpected acceleration in inflation (see below) mirrors what we’ve seen in several other major economies and supports our view that central banks globally will have to go “higher for longer.” Any expectations of easing in H2 remain far-fetched.

The two-day FOMC meeting begins tomorrow and will end Wednesday with an expected 25 bp hike. That is the safe choice right now and we see no need for the Fed to deviate from its cautious path. However, the hard part for the Fed will be convincing the markets that they are wrong about its perceived pivot. The Fed should leave the door wide open for further rate hikes and Chair Powell should stress that the Fed is prepared to continue hiking rates beyond 5% and keep them there until 2024, as the December Dot Plots showed. As things stand, the Fed is seen starting an easing cycle in H2 and we view that as highly unlikely. New Dot Plots and macro forecasts won’t come until the March 21-22 meeting. We will send out a more detailed FOMC preview later this morning.

We get some key January survey readings this week. Dallas Fed manufacturing index will be reported today and is expected at -15.0 vs. -18.8 in December. Dallas Fed services index and Chicago PMI will be reported tomorrow, with the latter expected to fall a tick to 45.0. ISM manufacturing will be reported Wednesday, with headline expected at 48.0 vs. 48.4 in December. Prices paid component is expected at 41.8 vs. 39.4 in December. ISM services will be reported Friday, with headline expected at 50.5 vs. 49.2 in December.


Spain inflation ran hot in January. It reported EU Harmonised inflation at 5.8% y/y vs. 4.8% expected and 5.5% in December. This was the first acceleration since July and supports our view that the global fight against inflation will be much tougher than markets expect. Indeed, Spain’s core inflation jumped half a percentage point to a record high 7.5% y/y. Germany and France report tomorrow. Germany’s EU Harmonised inflation is expected at 10.2% y/y vs. 9.6% in December, while France’s is expected at 7.0% y/y vs. 6.7% in December. Italy reports Wednesday and its EU Harmonised inflation is expected at 10.7% y/y vs. 12.3% in December. Eurozone also reports Wednesday. Headline is expected at 9.0% y/y vs. 9.2% in December, while core is expected at 5.1% y/y vs. 5.2% in December. Further upside surprises in the inflation readings means the ECB hawks will remain in control of the narrative, at least for now.

ECB tightening expectations have picked up a bit. In turn, the euro is seeing a bit of a bid as the week begins. The ECB is expected to hike all rates by 50 bp when it meets this Thursday. Looking ahead, WIRP suggests over 75% odds of another 50 bp hike March 16. A 25 bp hike May 4 is almost priced in, as is a last 25 bp hike in Q3 that would see the deposit rate peak near 3.5%. We fully expect President Lagarde to stick with her existing forward guidance that points to a 50 bp hike at the March 16 meeting, when updated macro forecasts will be released. We continue to push back against euro bullishness, as the full economic impact of ECB tightening has yet to be felt. The warm winter so far has led to increase optimism on the eurozone growth outlook but we remain cautious.

Germany reported soft Q4 GDP data. Flat q/q was expected but GDP instead came in at -0.2% vs. a revised 0.5% (was 0.4%) in Q3. As a result, the y/y rate came in at 0.5% vs. 0.8% expected and a revised 1.3% (was 1.2%) in Q3. Of note, Spain reported GDP last week and growth came in a tick higher than expected at 0.2% q/q vs. a revised 0.2% (was 0.1%) in Q3, while the y/y rate came in 2.7% vs. 2.2% expected and a revised 4.8% (was 4.4%) in Q3. France (flat q/q expected), Italy (-0.2% q/q expected), and eurozone (-0.1% q/q expected) will all be reported tomorrow. Let’s see if Germany’s recent optimism about avoiding a recession is warranted.

Spain reported firm December retail sales. Sales rose 4.0% y/y vs. a revised -0.5% (was -0.6%) in November. Tomorrow, Germany reports December retail sales and is expected at -0.5% m/m vs. 1.7% in November, while France reports December consumer spending and is expected at 0.1% m/m vs. 0.5% in November. Eurozone retail sales will be reported next Monday and are expected at -0.5% m/m vs. -0.9% in November.

U.K. Prime Minister Sunak said he will not raise taxes to fund pay increases for workers in the National Health Service. He said that “Nothing would give me more pleasure than to wave a magic wand and have you paid lots more.” Therein lies the negative fundamental backdrop for the U.K. High inflation has eroded real wages and Bank of England tightening has hurt households, but fiscal policy has been forced into a pro-cyclical tightening stance by the disastrous September mini-budget from former PM Truss and her Chancellor Kwarteng. If investor sentiment hadn’t been so damaged, the Sunak government might have been able to slip though some public sector wage hikes funded by debt issuance. That is no longer possible but it seems that further tax hikes are off the table too. Bottom line: the government is caught in an austerity straight-jacket with no relief seen on the horizon. Unfortunately, this suggests no end to the public sector strikes that are crippling the economy.

Meanwhile , Bank of England tightening will continue. It meets Thursday and is expected to hike rates by 50 bp. However, nearly a third of the analysts polled by Bloomberg see a smaller 25 bp move. WIRP suggest nearly 85% odds of a 50 bp hike, while a 25 bp hike March 23 is fully priced in. After that, a final 25 bp hike in June or August is nearly priced in that would see the bank rate peak near 4.5%. Recall that for the 50 bp hike at the last meeting December 15, , the 6-3 vote was surprising in that Dhingra and Tenreyro voted to keep rates steady and Mann voted for a larger 75 bp move. Updated macro forecasts will be released this week.


Bank of Japan Governor Kuroda said the bank will maintain its 2% inflation target and continue monetary easing. Appearing before Parliament, Kuroda noted that he can’t communicate any specifics of policy decisions in advance and added that more time is needed to examine the impact of the December tweaks to Yield Curve Control. Elsewhere, a panel of experts recommended that the government and BOJ revise their joint policy statement from 2013. Panel head Yuri Okina said “A new joint statement as we propose it will make the responsibilities of the government clearer. The normalization of yield functions and the bond market would likely mean a need to comprehensively rethink monetary policy, including its various methods of conduct.” Most observers believe that a change to the joint statement would be made before any exit from accommodation is seen. No change is expected at the next policy meeting is March 9-10. However, WIRP suggests odds of liftoff then rise to nearly 50% at the April 27-28 meeting and nearly 85% at the June 15-16 meeting.

New Zealand reported soft December trade data. Exports came in at 10.5% y/y while imports came in at 1.8% y/y. Export growth is the slowest since July, while import growth is the slowest since February 2021. The economy is showing some signs of slowing but inflation remains too high and so RBNZ tightening expectations remain elevated. Next policy meeting is February 22 and WIRP suggests a 50 bp hike is fully priced in, with nearly 40% odds of a larger 75 bp move. New macro forecasts and expected rate path will be released then with 2026 added to the forecast horizon. The swaps market is pricing in a peak policy rate between 5.25-5.5%, which is close to the bank’s current expected rate path from November.

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