Euro Selling Threatened as German Unemployment Climbs, Deflation Continues (Euro Open)

Published September 30th, 2009 - 11:20 GMT

The Euro may face selling pressure in European hours as German unemployment climbs to the highest in nearly two years while Euro Zone consumer prices shrink again in September, threatening trap the currency bloc in a deflationary spiral of weak growth and low interest rates.

Key Overnight Developments

• Aussie Rallies on Retail Sales Gains But Long Term Prospects Bleak
• NZ Business Confidence Surges But Rates Outlook Weak on Low Inflation
• Japan: Industrial Production As Expected But Housing Starts Tumble

Critical Levels

The Euro gained in overnight trading, testing as high as 1.4644 against the US Dollar, while the British Pound added as much as 0.7% against the greenback. We remain short GBPUSD at 1.6617 and EURUSD at 1.4710.

Asia Session Highlights

Australia’s Retail Sales printed better than expected, adding 0.9% in August to register the first gains in three months. Economists were forecasting a 0.5% result. July’s outcome was revised a bit higher to -0.9% from the -1.0% that was originally reported. Department store sales led the metric higher, adding 2.4%. The Australian Dollar jumped higher as the data crossed the wires, pushing to test the 0.88 level against its US counterpart for the first time in over a year. The long-term trend in retail sales looks less encouraging, however: sales added just 5.8% from a year before, a relatively minor improvement over July’s five-month low of 5.3%, while the Private Sector Credit report revealed that lending to businesses and households grew just 2.5% in the year to August, the slowest pace on record. Coupled with expectations that that unemployment will rise well beyond the current six-year high into 2010, this outcome bodes ill for consumption and thereby overall economic growth as Australians are unable to earn or borrow to finance their spending.

New Zealand’s NBNZ Business Confidence surged to a decade high in September, showing that 49.1 percent of companies surveyed for the report expect the economy will improve over the next 12 months versus 34.2 percent in the previous month. The number of companies expecting sales and profits to rise in a year from now rose to 32.2% from 26% in August. However, the number for firms planning to raise prices fell for the first time in three months, suggesting inflation is expected to remain contained. This points to the likelihood that interest rates will remain low despite any early gains in the economy’s performance, offering little support to the Kiwi dollar as monetary policy begins to turn the corner elsewhere.

Japanese data was broadly disappointing: Industrial Production printed in line with expectations, but Housing Starts fell much more than economists expected to register the largest drop in close to two years, hinting that builders see little hope for a pickup in demand for housing as unemployment continues to rise while the number of new mortgages falls to the lowest since mid-2007.

Euro Session: What to Expect

Germany is expected to have lost 20,000 jobs in September to push the Unemployment Rate to 8.4%, the highest in nearly two years. More of the same is likely in the months to come: a survey of economists polled by Bloomberg forecasts the jobless rate will average at 9.78% next year. This raises serious doubts about the economy’s ability to sustain momentum after the flow of government cash dries up, with job losses weighing on incomes and discouraging spending. Technically speaking, the Euro Zone’s largest economy exited recession after the economy grew in the second quarter, but the positive outcome owed entirely to fiscal stimulus: Germany’s government spent 85 billion euro to prop up consumption, including a subsidy to keep employers from firing workers (which allegedly saved close to 500k jobs) and a credit towards scrapping old cars for new ones, while similar programs overseas boosted exports. Additional stimulus will be hard to come by considering Germany’s new ruling coalition has Angela Merkel’s CDU party sharing power with the free-market oriented FDP who have been very critical of her intervention into the economy last year and as the fiscal deficit tops 5% of GDP for the first time in at least a decade in 2010.

The initial estimate of September’s Euro Zone Consumer Price Index are set to show prices shrank at an annual pace of -0.2% for the second consecutive month. German CPI surprised to the downside earlier this week against a backdrop of dovish commentary by European Central Bank President Jean-Claude Trichet who said that the economic outlook for the currency bloc was “surrounded by uncertainty”. Another downside surprise this time around is likely to weigh further on interest rate expectations, opening the door for Euro selling, as traders reckon that a drop in inflation expectations stands to unleash a deflationary spiral whereby consumers and businesses suspend spending and investment to wait for a better bargain in the future, bringing economic activity to a virtual standstill.

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