Why is today's inflation data in Europe so important?

"The fight against inflation has not yet been won" – said the president European Central Bank (ECB) Christine Lagarde at the annual central bankers' conference in Jackson Hole last Friday.

Lagarde added that interest rates in the European Union would have to remain high "for as long as necessary" to slow still high inflation. Therefore, the upcoming euro zone inflation data will be of great importance in determining the next change in interest rates by the ECB.

Money markets are pricing in the likelihood of the ECB suspending the rate increase in September  at 51%. Bloomberg World Interest Rate Probablities (WIRP) suggests that the probability of a 25 basis point increase is close to 35% next month, 50% on October 26 and almost 70% for the December 14 meeting.

What can we expect from the next European inflation report?

Eurostat will publish preliminary estimates of the Harmonized Index of Consumer Prices (HICP) for the euro area today.

Annual core HICP inflation, a rate closely watched by the European Central Bank, is likely to fall to 5,3% in August from 5,5% in July. The euro area's Main Harmonized Consumer Price Index is expected to rise to 5,1% y/y in August, a slight slowdown compared to July's increase of 5,3%.

In turn, on a monthly basis, the HICP index for the old continent will probably fall by 0,1% in August. Core HICP inflation is expected to amount to 0,3% in the month under review, compared to a decline of 0,1% in July.

Inflation in more than 20 countries using the euro fell from a high of 10,6% last year to 5,3% last month, largely reflecting a sharp decline in energy prices. However, inflation remains more than twice the ECB's target of 2,0%.

The ECB's dovish expectations gained momentum after activity in the dominant services sector fell for the first time this year and the deterioration in the manufacturing sector continued, a PMI survey showed. The euro zone's purchasing managers' index (PMI) rose to 43,7 in August, compared with market forecasts of 42,6 and above 42,7 in July. The index reached its highest level in 3 months. However, the services PMI fell to 48,3 in August from 50,9 in July, hitting a 30-month low and well below estimates of 50,5.

The European Central Bank maintains its commitment to bringing inflation back to its 2,0% target without triggering a recession, putting it in a difficult position on the interest rate outlook.

As usual, some Member States have already published their national inflation data for August, giving clues as to the direction of development of all HICP data for the euro area.

Spain's consumer price index (CPI) rose 2,6% y/y in July thanks to higher fuel prices, preliminary data showed on Wednesday.

The harmonized annual inflation rate increased to 2,6% from the June figure of 2,3%, while being in line with the expected value.

In August, the headline HICP index in Germany increased by 6,4% compared to a growth of 6,5% in the previous month and a forecast for August of 6,2%.

Since annual inflation in Germany and Spain decreased slightly in August, contrary to expectations, this increases the risk of a positive surprise in inflation data in the euro zone.

How can inflation affect the Eurodollar?

Hotter-than-expected data on headline and core HICP inflation may strengthen expectations for a September rate hike. In such a scenario, the EUR/USD rate could extend the rebound towards the psychological level of 1,1000. However, if inflation in the euro zone declines at a faster rate than expected, the main currency pair will likely test the area of ​​1,0700.