Investors were shocked and in awe when they saw the inflation data in the Eurozone. Everyone expected that deflation, which had lasted for five months, would be over and consumer prices would start to rise in Europe. And so it happened, but inflation grew by 0.9% instead of 0.3%. In theory, this should have led to the euro's impressive growth, but the market just stagnated in one place instead. Thus, this behavior should be clarified.
The fact is that from investors' viewpoint, the growth of consumer prices is great. After all, if the prices of goods and services are rising, then the cost will already be higher due to the time lags between investments in their production and the final sale. In other words, by investing in the production of a certain product, its price will be higher than at the initial stage as soon as it hits the shelves and is sold. This means that inflation guarantees a return on investment, which makes sense to invest in creating new jobs and expanding production.
As with deflation, the picture is diametrically opposite. Therefore, it's not surprising that markets are responding positively to rising inflation. However, deflation is quite a specific situation with disastrous risks. Consumers see that prices are falling, and begin to massively postpone some purchases for a later time. Let's just say that the decision is made to wait for the moment when prices will become even lower. Simply put, why buy something now if this product will cost even cheaper tomorrow? Postponing the demand. Such an outlook made producers and sellers reduce the output of goods and services. After all, you first need to sell what is already in warehouses, which are emptied very slowly.
But at some point, consumers decide that it's time to buy, as the price seems attractive. All the pent-up demand falls on the sellers at once. Stocks are rapidly being depleted and need to be replenished. However, the problem lies on the production cycle, and there is a certain time gap between the order of the goods and their delivery. As a result, sellers are faced with a situation where they have few goods, and demand continues to grow. According to the laws of supply and demand, this leads to an increase in prices. Moreover, this very growth may turn out to be so sharp that the situation will get out of control and prices will rapidly increase. This will lead to the fact that consumers will be left without money or they may have, but it will no longer cost anything.
It is clear that this is the most terrible scenario, and it is still ridiculous to say that this is exactly what is happening in Europe. However, the inflation growth from -0.3% to 0.9% clearly makes us think that such a situation may become a reality. This is the very reason why investors, who are simply trying to understand the reasons for such a sharp rise in the level of consumer prices, are in daze.
Inflation (Europe):
There is no doubt that the situation in Europe is very far from ideal. Here, the business activity index in the service sector declined from 46.4 to 45.4, while the composite one also fell from 49.1 to 47.8. And although a slightly stronger decline was expected, we are still talking about their reduction.
Composite PMI (Europe):
The United Kingdom has a similar situation. The country's business activity index in the service sector plunged from 49.4 to 39.5, while the composite business activity index fell from 50.4 to 41.2. However, this is more like a simple collapse than a decline. This is largely the result of a new trade agreement between the UK and the European Union, which has largely increased bureaucratic barriers for British businesses.
Composite PMI (UK):
As for the United States, it was the opposite. The business activity index in the service sector rose from 54.8 to 58.3, while the composite index has grown from 55.3 to 58.7. Both exceeded what was forecasted. Moreover, ADP data showed employment growth by 174 thousand, instead of 50 thousand. This is ahead of the US Department of Labor report. Unfortunately, this did not lead to any dramatic changes in the market, since investors are more shocked with Europe's inflation data.
Employment Change (United States):
Formally, today's main event is the meeting of the Board of the Bank of England. However, it is unlikely to affect investors' mood at all. After all, it is not ideal to take any drastic decision after the ECB and the Fed did not change anything and left everything as it is. In this case, BoE is not expected to change anything in its own monetary policy. Although they have enough reason to cause a scene not only because of the notorious trade agreement with the EU, which seems to be causing huge losses for British businesses. It's also about the catastrophic epidemiological situation, which is getting worse every day.
We are almost certain that the Bank of England will only focus on the situation with the COVID-19, carefully ignoring trade issues with the European Union. But this may well be regarded as a sign of weakness, as well as unwillingness to take any serious measures to support their own economy. So, at best, the results of the BoE meeting will lead to the fact that the pound, which has been showing a downward trend since the morning, will return to its original positions. However, it should also be considered that the pound may remain at new levels in the end, slightly below the range in which we are used to seeing it lately.
Investors are now much more concerned with the issue of prices and consumer activity in Europe, and some answers may be provided by retail sales data. Surprisingly, they can provoke further weakening of the single European currency, although the rate of decline in retail sales should slow down from -2.9% to -0.2%. It can be noted that the price level has sharply risen, while retail sales continue to decline.
In other words, this could confirm that the price growth is caused by a sudden imbalance between supply and demand, which means that inflation can continue to grow quite rapidly. As a result, the ECB will no longer worry how to accelerate inflation to 2.0%, but how to slow it down to this desired level. This will be accompanied by a sudden and abrupt change in the direction of monetary policy. Business is already suffering badly from the endless restrictive measures associated with the pandemic, and abrupt changes in monetary policy will only abolish many companies, especially small ones.
Retail Sales (Europe):
In this context, the expected slight increase in the number of applications for unemployment benefits in the US looks somewhat uninteresting. Here, the number of initial applications is expected to rise by 3 thousand, and repeated applications by another 9 thousand. Simply put, the total number of applications will remain practically unchanged. At the same time, noting yesterday's ADP data, it is very likely that the number of applications will even decline. It can be recalled that an increase in the number of applications has been forecast for several weeks in a row, but their number is only going down. In general, this shows that the US labor market is gradually recovering.
Number of re-claims for unemployment benefits (United States):
The EUR/USD pair did not show proper activity, which resulted in a slowing down within the psychological level of 1.2000. To prolong the corrective movement, market participants should hold the quote below 1.2000, or else, there will be a natural rebound.
The GBP/USD pair continued to decline after a short stagnation, where the quote is already moving at the levels on January 19. In order to see further decline, the quote must hold below 1.3600 in the four-hour period. Otherwise, a pullback will occur in the direction of 1.3650.
