Geoff Yu at BNY argues that upcoming German CPI and Eurozone flash CPI are critical for European Central Bank expectations, with markets already pricing a near-certain September hike. While services inflation is softening and second-round wage effects remain unclear, stronger headline readings could reinforce hawkish ECB messaging and challenge Europe’s fragile cyclical recovery and activity improvements.

Inflation data to steer ECB path

“We fully acknowledge that the odds are stacked against the doves as the week ahead sees key inflation releases in Germany and the broader Eurozone. Upside surprises in France and Spain have provided validation for the hawks, and OIS markets now suggest a 97% chance of a hike in the September meeting.”

“We still see risk reward in fading the “certainty,” especially at current levels, but the ECB is likely intent on pushing for additional preemptive action.”

“Headline inflation globally has its own supply challenges, but we believe the ECB is also making a judgment on the reaction function to wages, which still seems excessive. Even some of the more hawkish members have highlighted that there’s no clear evidence of second-round effects, as President Christine Lagarde acknowledged at the July meeting.”

“We also stress that services inflation, which is a better gauge of wage pressures and domestic demand, continues to decline across Europe.”

“The ECB’s pre-decision quiet period begins in the coming days, leaving the inflation and PMI figures the core releases for central bank signaling. German CPI aside, Eurozone flash CPI is out on Tuesday, where a rise in headline inflation would reinforce pressure on ECB rate expectations – validating Executive Board Member Isabel Schnabel’s extremely hawkish messaging.”

“Final PMIs across the Eurozone and U.K. will show whether recent improvements in activity are holding, but the embedded price indices will provide further examples of pass-through risk.”