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European Tourism and Its Impact on Inflation

Posted: Friday, September 4th, 2020

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This is the NFP week and, as such, most of the focus is on the U.S. data. But European inflation (or the lack of it) poured some cold water on Euro bulls as it raises some major problems ahead.

Two things worth mentioning on the Euro front, happened this week. One is that the EURUSD reached 1.20. If history is giving us any clues about the levels the ECB will tolerate or not, the 1.20 is such a level. Shortly after it traded at the 1.20, the ECB delivered a verbal intervention. Like a warning, if you want.

Another one is the sharp drop in inflation. It threatens to drop below zero, undermining the ECB’s credibility.

European Inflation

No Tourism, No Inflation

One of the main drivers of lower inflation (in this case, disinflation – this is the correct term to use when inflation drops but remains positive) is the tourism industry. The South always acted as the place to spend holidays in. France, Spain, Portugal, Italy, or Greece – rely heavily on tourist arrivals. This year, tourists did not come.

Or, if they did, they did so in much smaller numbers, with reluctancy to spend, and they found few opportunities to spend their money – most restaurants are closed, restrictions everywhere. Many chose to remain home. And this is what a breakdown if inflation data tells us.

The tourism and travel-related items are the main drivers of the slowdown in services inflation. This is hardly a surprise. For instance, think of yourself when in a holiday.

People save all year to go on a nice vacation. Once there, they spend more than usual, much more than in a normal, regular month. Hence, the summer holidays in Europe were always viewed as inflationary. Not this time around!

Which brings a big problem at the ECB’s door. There is already a EUR1.35 billion in announced wallet for the pandemic program. However, financial conditions remain tight.

Next week it is the ECB’s turn to explain what it plans to do next. More precisely, the market will put pressure to find out how much more will the ECB need to buy to really move the needle?

One thing is sure. The ECB will not tolerate such low inflation levels. But it does not mean that the EUR will weaken just because the central bank says so.

Just ask the Swiss National Bank (SNB) about its experience with the 1.20 EURCHF exchange rate floor.

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