Eurozone headline HICP inflation rose to 2.9% year on year in July, matching consensus and up from 2.8% in June, according to Eurostat’s preliminary release. On a month-on-month basis, prices increased 0.2% after a 0.1% decline in June, pointing to renewed short-term momentum in the inflation basket used across the European Monetary Union.
Core HICP, which strips out food, energy, alcohol and tobacco, accelerated to 2.5% YoY from 2.4% and exceeded expectations for a flat reading at 2.4%. The monthly core measure was unchanged, following a 0.2% rise previously. In early trading after the data, the euro was slightly softer, with EUR/USD down 0.1% to around 1.1517.
Outlook for the Euro and ECB Policy
With Eurozone headline inflation climbing to 2.9% and core inflation unexpectedly rising to 2.5%, we believe the Euro’s initial dip to 1.1517 represents a strong buying opportunity. This sticky core data suggests the European Central Bank (ECB) will have to keep interest rates restrictive for longer to cool down the economy. We recommend traders look at long Euro positions using short-term call options to capitalize on an expected currency rebound over the coming weeks.
Implications for Derivatives and Volatility Strategies
This surprise uptick in underlying inflation will heavily impact Eurozone debt and interest rate derivatives. Historically, when core inflation remains stubborn above the ECB’s 2.0% target, short-term interest rate futures quickly price out aggressive rate cuts. We suggest selling Euribor futures or entering payer swaps, as the market recalibrates for a more hawkish central bank policy path through the rest of the quarter.
Additionally, the divergence between stubborn Eurozone price pressures and the easing cycles of other global central banks will likely drive up currency volatility. Derivative traders should consider implied volatility strategies, such as buying EUR/USD straddles, to profit from wider price swings in the near term. Hedging portfolios against sudden hawkish rhetoric from ECB officials during upcoming August speeches should also be a priority.
