Euro Deflated by Post-Inflation Rate Cut Chatter

Traders are already grappling with the prospect of an ECB rate cut in the week ahead. The euro plunged the most in 4 months Thursday on a weak inflation report. The Canadian dollar was the best performer on the day after a dismal month for the loonie; the market will remain focused on the commodity bloc with the official Chinese PMI up next. 

The European economy is in the midst of a modest recovery but inflation was at just 0.7% in the past year, well below the 1.1% expected. Will the ECB insist that better growth will spark inflation or be forced to cut rates? The problem is that rates are near the zero bound and lowering the main refi rate would narrow the corridor to the deposit rate which is at zero percent. That could mean negative deposit rates. Either option carries risks to the financial system but economists were lining up Thursday to predict a cut anyway. Ashraf covered in today's edition of the Premium Insights his take on the internals of possible rate cut and the dynamics of the euro's reaction to such action.

Only two days ago the ECB's Nowotny said a cut wasn't realistic. Could the story change that quickly? Euro traders certainly believe so, or at least they see the possibility. EUR/USD plunged to 1.3580 in a one-way move.The momentum is certainly lower but the market has nearly a week to lose faith in the rate cut narrative.

Up next, at 2100 ET, 1:00 GMT,  China releases the official manufacturing PMI. It's expected to inch to 51.2 from 51.1. Forty-five minutes later HSBC releases its final PMI and it's expected to be revised to 50.7 from the initial disappointing reading at 50.2.