Euro hits 3-year high on breakthrough for German coalition talks

The euro surged against rivals on Friday, hitting a three-year high against the dollar after German lawmakers reached an agreement on a blueprint for a ruling coalition between Chancellor Angela Merkel’s Christian Democrats and the opposing Social Democrats.

The U.S. dollar meanwhile held the losses it incurred on the back of euro strength, even as data showed that core inflation rose slightly more-than-expected in December.

What are currencies doing?

The ICE U.S. Dollar Index

DXY, -0.65%

which measures the buck against a basket of six rivals, was down 0.4% to 91.483.

Meanwhile, the WSJ Dollar Index

BUXX, -0.42%

which gauges the greenback against a basket of 16 currencies, dropped 0.2% to 85.25.

The euro

EURUSD, +0.8892%

 shot to $1.2117 from $1.2034 late Thursday in New York. The euro hasn’t traded that high against the dollar since January 2015.

The British pound

GBPUSD, +0.9602%

also shifted higher against the dollar, rising to $1.3652 from $1.3539 on Thursday.

Against the Japanese yen

USDJPY, +0.14%

the U.S. currency bought ¥111.66 compared with ¥111.26 on Thursday.

Elsewhere in emerging markets, the Brazilian real

USDBRL, -0.1368%

 has been in focus, after S&P cut the country’s credit rating by one notch to BB- driven by its fiscal outlook. Brazil’s government is trying to push through a pensions reform package to sort out its public finances, but the vote on the legislation has been delayed until Feb. 18.

The real’s response has been volatile, initially falling against the dollar, then reversing into gains, before selling off again. One dollar last bought 3.2262 real, up from 3.2154 real late Thursday.

What’s driving the market?

The euro shot up midmorning during European trading hours after Chancellor Angela Merkel’s center-right CDU party reached an initial deal to form a coalition with Martin Schulz’s center-left SPD. Germany held elections last September in which incumbent Merkel managed to win but then subsequently struggled to secured a ruling coalition.

The euro was already higher when that news broke, extending gains from Thursday when the minutes from the ECB’s December meeting revealed that policy makers indicated a possible hawkish shift toward monetary policy in 2018.

The dollar index was weaker on the back of that, although it attempted to claw back some of its losses in the aftermath of consumer-price index and retail-sales data, which painted a supportive picture. December core inflation rose 0.3%, compared with MarketWatch consensus forecast of 0.2%, while headline numbers were in line with estimates at 0.1%. On the year, inflation rose 1.8%, up modestly from 1.7% before.

Despite the sluggish dollar, market participants saw Friday’s data as another indicator that the Federal Reserve, which is planning to raise interest rates up to three times this year, could make its first move in March.

In Brexit news, the Spanish and Dutch finance ministers have reportedly agreed to support a soft Brexit, which helped sterling advance on Friday. A soft exit from the EU would keep the U.K. closer to its biggest trade partner.

What are strategists saying?

“There are two ways to look at the latest CPI figures,” said Jacob Deppe, head of trading at online platform Infinox. “The first is that core CPI is stubbornly below target and so monetary policy should be held until the Fed has a clearer picture of the state of the U.S. economy.”

“The second is to ignore the fact core CPI is below the Fed 2% target and argue it has held pretty steady, and close enough to target, not to halt further rate hikes,” Deppe added.

“The Fed should continue to tighten gradually given where the unemployment rate, equity markets, house prices, corporate debt levels and global growth indicators are at,” said Chris Probyn, State Street’s chief economist, in a call with MarketWatch on Thursday, adding that the central bank could still find itself in a situation where its hawkish agenda needs to be put on hold in the future.

Still, “inflation has been similar last year and the Fed hiked three times,” Probyn said.

“Our outlook for the dollar remains bearish in the short-term as it is clear that investors are skeptical over how bullish they will be in 2018 and until they get a better idea on what to expect, further defensive trading should be expected,” said Konstantinos Anthis, on the ADS Securities research team, in an email to clients.

What are the data?

Retail sales rose 0.4% in December, falling just short of the 0.5% MarketWatch consensus estimate. Excluding cars, sales also increased 0.4%, beating expectations of 0.3%.

Data for business inventories for November are due at 10 a.m. Eastern.

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Written by sortiwa