EUR/USD Rebounds As German Producer Prices Soar

Key Insights

• Germany’s PPI is up by 33.6% on a year-over-year basis. 
• Traders look ready to bet on more aggressive moves from the ECB. 
• The ECB will have to solve problems with bonds of weaker EU members. 

Germany’s PPI Reaches Multi-Decade Highs

EUR/USD is trying to settle back above 1.0500 after the release of Producer Prices data from Germany.

Germany’s PPI report indicated that Producer Prices increased by 1.6% month-over-month in May, compared to analyst consensus of 1.5%. On a year-over-year basis, Producer Prices increased by as much as 33.6%.

This is a real catastrophe for Europe’s leading economy. Last time, such PPI levels were seen after World War II. The situation in weaker EU members is even worse.  For example, Producer Prices in Greece increased by 48.8% in April on a year-over-year basis.

High Producer Prices will inevitably push consumer prices higher, so the ECB will have to fight inflation. Such expectations are bullish for EUR/USD.

Euro Area Bond Markets In Spotlight

While the European Central Bank will have to come up with measures to fight inflation, it will find itself in an uncomfortable position due to the spread between Germany’s bonds and bonds of weaker EU members.

Italy’s 10-year bonds are currently yielding about 3.70%. The yield of 10-year Greece bonds is near the 4.00% level. Meanwhile, Germany’s 10-year bonds are yielding 1.70%.

The ECB has already warned that is sees “fragmentation” as a risk for the eurozone. Unfortunately for the ECB, there is only one way to push the yields of weaker EU members to lower levels – the ECB must buy these bonds to increase their prices.

Such efforts at a time of high inflation can only lead to more problems on the pricing front. At some point, the ECB will have to choose between inflation and the potential fragmentation of the eurozone, and its choice will have a material impact on EUR/USD.

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