Key Insights
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Euro Area PPI inflation was below analyst expectations in May.
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ECB will try to limit spreads between the bonds of the EU members, but it remains to be seen whether this financial operation will be successful.
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EUR/USD traders should closely monitor the developments in the European government bond markets.
Euro Is Mostly Flat Against The U.S. Dollar
EUR/USD is mostly flat after the release of Euro Area Producer Prices report. The report indicated that Euro Area Producer Prices increased by 0.7% month-over-month in May, compared to analyst consensus of 1%. On a year-over-year basis, Euro Area Producer Prices increased by 36.3%, while analysts expected that they would grow by 36.7%.
While the Euro Area Producer Prices report was a bit better than expected, the inflation picture remains grim. Inflationary pressure stays strong, so the European Central Bank will have to raise the interest rate.
At the same time, it is not clear whether the ECB will be able to contain the rise in government bond yields of the weaker EU members like Italy without pushing Germany’s yields to new highs.
As a reminder, the current plan is to use the proceeds from Germany, France, and Netherlands bonds to buy bonds of Italy, Spain, Portugal, and Greece. The idea is to limit the spreads between the yields of stronger EU members and weaker EU members, but it remains to be seen whether it will work well.
Another Bond Crisis In The Making?
The yield of 10-year Italy bonds has recently declined from 4.30% to 3.30%, so the first phase of the panic is over. Back in 2018, when the Fed raised rates and triggered a sell-off in the equity markets, the yield of 10-year Italy bonds reached 3.85%.
In 2011, during the European debt crisis, the yields exceeded 7.0%. This time, the ECB does not have the firepower to deal with a crisis of this magnitude as its balance sheet has significantly increased and it can’t print more money without pushing the Eurozone inflation above the 10% level.
Problems on the EU debt front may push traders to the safety of the U.S. dollar and take EUR/USD below 1.0350. In this light, traders should closely monitor the developments in the European government bond markets. In case the ECB fails to limit the yield of Italy bonds, EUR/USD may find itself under additional pressure.
For a look at all of today’s economic events, check out our economic calendar.
This article was originally posted on FX Empire
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