Stronger Eurozone impact on rates and FX - Westpac

According to Richard Franulovich, Research Analyst at Westpac, the ECB recently signalled the beginning of the end for ever expanding monetary accommodation and suggests that this theme has a further to run.

Key Quotes

“Allowing for long and variable lags the stabilisation in Eurozone growth should eventually produce a durably stronger labour market and inflation picture. Eurozone core inflation tracks the region’s unemployment rate with a 3 quarter lag. At 9.6%, the Eurozone’s unemployment rate suggests still significant excess capacity. But, Eurozone unemployment has also fallen 2.5ppts in the last several years and judging by the Phillips curve relationship between the labour market and inflation that should at a minimum help reduce disinflation risks. Taken at face value the fall in Eurozone unemployment could see core inflation tracking nearer 1.5%, from its current 0.9% rate by year’s end.”

“Improved Eurozone growth outcomes put the region in a better light relative to the US too. With Eurozone growth underperformance waning we should eventually also see Eurozone labour market underperformance moderate too. Eurozone unemployment sits about 5ppts above the US but that gap could narrow considerably in the next year or two if relatively stronger Eurozone growth in recent quarters is anything to go by.”

“Less weak Eurozone labour market and inflation outcomes could have a significant impact on FX and fixed income markets.”

“The size and timing of any US tax cuts/tax reforms and the myriad of political risks in Europe this year could upend the aforementioned commentary. But, as it stands right now relatively less weak Eurozone labour market and inflation outcomes should help stabilise the long term trend in the Bund-Treasury spread and the EUR/USD exchange rate.”