Focus today will be on the final services and composite PMIs out of the Eurozone and UK as well as speeches by the ECB’s Isabel Schnabel and Ignazio Visco. Recent data releases have rekindled market fears about a potential bout of stagflation in Europe.While investors’ current worries pale in comparison with their fears about the European economic outlook last year, any escalation of the stagflation concerns could become a major negative for both the EUR and GBP.
Indeed, a potential episode of weak growth and sticky inflation should undermine the credibility of the ECB’s and BoE’s hawkish forward guidance and thus erode the real rate advantage of the two currencies. A stagflation scenario for the Eurozone in particular could further undermine the appeal of its stock and bond markets. On the day, the FX market reaction will depend on the extent the PMIs add to the market stagflation fears. In that, we think that potential downside surprises could have a disproportionately greater negative impact on the EUR and GBP than any boost from any potential upside surprises. We also think that the EUR could be vulnerable to any fresh dovish surprises from Isabel Schnabel on the back of the ECB speeches yesterday. We therefore continue to view them as vulnerable to further correction lower ahead of the September ECB and BoE meetings.

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