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Friday, August 29, 2008 4:36 PM

EuroZone Inflation Eases

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Bloomberg is reporting European Economic Confidence Drops, Inflation Eases.

Aug. 29 (Bloomberg) -- Europeans' confidence in the economic outlook fell more than economists forecast this month as the economy teetered on the brink of a recession. Inflation unexpectedly slowed.

The euro pared gains after the reports, which signaled the slump in economic growth is extending through the third quarter and a 20 percent drop in oil prices from a record $147.27 a barrel last month is easing inflation pressures. Consumer-price increases are still above the European Central Bank's limit, prompting policy makers including Axel Weber to indicate they are in no hurry to cut interest rates even as expansion slows.

"The euro-zone economic situation is deteriorating markedly," said Carsten Brzeski, an economist at ING Group in Brussels. "Therefore, it is somewhat striking that some central bankers still consider interest rates to be accommodative."

Economists had forecast that inflation would remain at 4 percent, a 16-year high, in August, according to the median estimate of 31 economists in a Bloomberg News survey. National data this week showed inflation in Germany, Europe's largest economy, Spain and Belgium eased this month.

Confidence among euro-area manufacturers fell more than economists forecast to minus 10 this month from minus 8 in July, while sentiment among retailers also declined, according to today's report from the commission. Consumer confidence rose 1 point from July's minus 20, staying close to a 5 1/2-year low. In the U.K., consumer confidence stayed near a record low in August, GfK NOP said today in a separate report.

In the euro area, unemployment remained at 7.3 percent in July, another report showed.

European companies and consumers see less chance of prices rising, the data indicate. A measure of companies' selling-price expectations fell to 17 in August from 20 in July. Consumers' outlook for prices dropped to 22 from 30, below its average reading for the past 18 years.
Euro vs. US Dollar Weekly

click on chart for sharper image

A chart shows the Euro is consolidating at the lows, right on a weekly trendline. Axel Weber might not be in a hurry to cut rates, but souring EuroZone sentiment suggests otherwise. In the very short-term, the idea that the ECB may not be in a hurry could be adding some support to the Euro.

There is also trendline support as shown. Should Axel Weber be proven wrong, and I suspect he will be, the Euro is poised for another drop vs. the dollar (all other things being equal). Support is at 135.

Fundamentally there has been every reason for the dollar to rally, and it has. I discussed the dollar at length on

In the August 29th post above I took a look at the idea that Treasury buying was supporting a US$ rally. My post was from a technical point of view, showing there is no intermediate term correlation between a rising dollar and foreign treasury purchases. Caroline Baum, bless her heart, pinged me with this comment from a "why" aspect that I was aware of but failed to mention.

Baum: Foreign central banks ACQUIRE dollars in an effort to keep their currencies from rising. The only question is, what do they do with them? Check out custody holdings of agencies: They are down in the last 6 weeks, not by a ton. These folks are only looking at one source of dollar purchases.

Ding, ding, goes the bell. I completely agree with Caroline as to why foreign banks do it. And the beautiful irony is that it is exactly the opposite of what has been proposed. However, I question if such intervention really works, or if it does work I question for how long. For example, the RMB has managed to rise significantly in spite of a "peg" that Strong Dollar Paulson constantly yaps about. Certainly the Japanese intervention schemes early this decade show the folly of trying to suppress the value of a currency.

Damn the intervention cries, the plain fact of the matter is this: The dollar's gonna go, where the dollar's gonna go. And where it's gonna go will depend more on interest rate differentials, expected changes in interest rate differentials, fluctuations in sentiment, and changes in balance of trade, as opposed to any real or imagined intervention schemes.

Looking ahead (once again, all other things being equal), if the ECB cuts rates faster than expected then the dollar is likely to rally vs. the Euro. And if the ECB stands pat longer than expected, then look for the Euro to be firm.

Yes, it's likely to be as simple as that. One would never know it from all the other explanations being bandied about.

Mike "Mish" Shedlock
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