Euro Back To 1.5500 As IFO, PMI Plummet. Will ECB Really Hike Rates?

Source: Daily FX

The EURUSD dropped more than 100 points from its open in Asia today after a slew of economic data surprised to the downside confirming the bear's long held thesis that the region's economy is beginning to buckle under the dual weight of high exchange rates and high energy prices. EZ Manufacturing PMI slipped to below the 50 boom/bust line for the first time in more than 2 years dragged lower by the sharp decline in French readings. In addition, the IFO survey fell more than expected printing at 101.3 versus 102.5 and considerably worse than May's reading of 103.5.

The euro which rallied at the end of last week on uber-hawkish rhetoric from ECB officials indicating that a rate increase next month is a foregone conclusion, returned to the familiar 1.5500 level as doubts crept into trader's minds regarding the certainty of the rate hike. Although over the past two weeks nearly everyone at ECB from President Trichet on down has echoed the common refrain that inflation remains too high necessitating further tightening, economic reality may temper any immediate plans to raise rates.

With energy costs soaring and high exchange rates making price hikes a major challenge to most European businesses does ECB really want to take this opportunity to put a chokehold on credit? EZ businesses rely on bank financing much more that US companies. Therefore an increase in the central bank call rate, were it to go through, would likely exacerbate the damage to European economic growth in the second half of 2008.

The answer to this question most likely lies with the price of oil. If crude continues to trade above $130/bbl the ECB may feel compelled to act despite the damage to growth, fearing the impact of persistently elevated inflation expectations. If on the other hand, oil prices start to ease this week dropping to $120/bbl or lower, the monetary authorities in Frankfurt may chose to stand down for another month.

Meanwhile, the North American calendar is barren for the day and therefore the US session may be dominated by the reaction to the IFO news and the action in the NYMEX pits. By the middle of the week attention will turn to the FOMC meeting and its consequent statement, but for now the markets should continue to digest the latest economic news from Europe.