The ECB expects inflation to be near target before the RBA does: EUR/AUD

As long as European inflation expectations are higher than those of Australia, EUR/AUD should remain bid

FOREX 6

Last weekend, ECB President Christine Lagarde said that there will be changes to the guidance at next week’s European Central Bank meeting in order to reassure traders that policy will not be tightened too quickly.  The ECB recently announced in its strategic review that their inflation target will be 2% over the medium term.  The reason for the change in guidance:  Inflation is expected to be over 2.5% towards the end of the year. In other words, they expect the inflation to be transitory.   Europe releases June’s Final CPI data on Friday and although the headline is expected to be near 1.9%, the core rate of inflation is only expected to be 1%.  If the final inflation data on Friday comes in hotter than expected, Christine Lagarde and the committee may have to reconsider their language next week.   July’s preliminary CPI reading isn’t due out until August 18th.

Everything you need to know about the ECB

Then there is the RBA.  At the July 6th RBA meeting, although they reduced bond purchases to A$4 billion per week from A$5 billion per week, the committee said they do not expect actual inflation to be within their 2%-3% target until 2024! (See our RBA recap). One of the reasons for this expectation of such a long duration until inflation reaches target is that the Delta variant of the coronavirus is making its rounds in Australia.  Sydney has been in full lockdown since June 26th, and the lockdown is expected to last until the end of July.  Now, the state of Victoria is entering a lockdown of its own, albeit only 5 days. (Victoria was on a nearly 4-month lockdown last year).  

With higher expected inflation and the exiting of lockdowns in Europe, the Euro is outperforming the Australian Dollar. EUR/AUD had been moving lower in an orderly channel from October 2020 until the late February lows, near 1.5343.  The pair broke higher out of the channel on March 23rd and then broke from a rising triangle on May 18th, near 1.5670.  EUR/AUD continued higher, forming an upward sloping channel and is nearing a key decision area for the pair near 1.6000, which is:

  1. The 50% retracement of the October 2020  highs to the February lows
  2. Horizontal resistance
  3. The top trendline of the upward sloping channel

Notice that the bottom green line of the rising channel also acts as the trendline for a rising triangle.  The target for a rising triangle is the height of the triangle, added to the breakout point. If price breaks above 1.6035, EUR/AUD could be on its way to the target and October 2020 highs near 1.6800. But the pair must first break through the 61.8% Fibonacci retracement level at 1.6223.  Horizontal support and the bottom trendline of the channel act as support near 1.5670. If the pair does break below, it can fall all the way to the previous lows near 1.5243.

Source: Tradingview, FOREX.com

Bottom line:

Europe: Higher transitory inflation should lead to target levels of 2% next year

Australia: Inflation will be at 2%-3% target in 2024!

EUR/AUD is knocking its head into the 1.5900/1.6000 level.  As long as European inflation expectations are higher than those of Australia, the pair should remain bid.  A break above 1.6035 and EUR/AUD could be off to the races.

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