Eurozone inflation was softer in June but core inflation managed to pick up ahead of the European Central Bank policy meeting later this week.

Inflation dropped to 1.3% from 1.4% the preceding month, in line with estimates, while core inflation advanced to 1.1% from 0.9%.

The euro was trading fairly flat on the data as it’s unlikely to do anything to alter perceptions about inflation and monetary policy. EURUSD remains well supported above $1.14 and is likely to be in a holding pattern until the ECB meeting on Thursday, when any minor changes in language or tone could set off the touch paper.

After the Bank of Canada’s well-choreographed hike last week, the focus is now on whether the ECB will continue with hawkish rhetoric or retreat to safer territory.

It looks more likely to hold fire. Comments from Mario Draghi last month that were taken as hawkish drove the euro to its strongest against the dollar in over a year. This looked a bit overdone and the ECB will not want to alarm markets further by stoking a ‘taper tantrum’. It also does want to add fuel to the euro fire as this will further dampen inflation expectations.

And the ECB cannot justify going significantly more hawkish now with inflation proving lacklustre. It could drop its reference to expanding quantitative easing if required. Last month it made two small changes to the monetary policy announcement – saying that risks are no longer ‘tilted to the downside’ and that policymakers don’t think rates will be cut further.

Removing this easing bias could be yet another important baby step on the road to normalisation. The ECB has tightened too quickly twice before and is loath to repeat the mistake. Any word on tapering should be held back until September when market action should pick up after the usual summer lull.

 

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