Euro heads for weekly loss against US Dollar on hawkish Fed outlook
- EUR/USD heads for a weekly loss as hawkish Fed outlook supports the US Dollar.
- Middle East supply concerns limit the decline in Oil prices and keep inflation risks elevated.
- ECB President Lagarde says the central bank is well positioned to respond to energy-driven inflation risks.
EUR/USD remains on the defensive on Friday and heads for a weekly loss as the Federal Reserve’s (Fed) hawkish policy outlook keeps the US Dollar (USD) firmly supported. A rebound in Oil prices and US Treasury yields adds pressure on the pair. At the time of writing, EUR/USD trades around 1.1462, near levels last seen in late July.
Crude prices fell earlier this week, dragging US Treasury yields away from multi-year highs, as Saudi Arabia stepped up efforts to reroute exports and restore its East-West pipeline, which was damaged in an attack last week.
However, the downside in Oil prices is proving limited as supply risks in the Middle East are far from over and keep inflation risks tilted to the upside. West Texas Intermediate (WTI) Oil trades around $97.20, recovering from an intraday low of $94.63. The rebound is pushing Treasury yields higher again, with the benchmark 10-year yield trading around 4.98%, not far from the 2007 high of 5.04% touched on Tuesday.
Heightened inflation risks prompted the Fed to deliver its first rate hike since 2023 on Wednesday, lifting the federal funds rate by 25 basis points to the 3.75%-4.00% range. The updated dot plot showed that 16 of 18 Fed officials expect at least one more increase this year, reinforcing expectations that borrowing costs could stay high for an extended period.
The prospect of additional tightening keeps the US Dollar in demand. The US Dollar Index (DXY), which tracks the Greenback against a basket of six major currencies, trades above 100.50, its highest level in seven weeks.
According to the CME FedWatch Tool, traders see around a 55% probability of another 25-basis-point Fed rate hike in October. Attention now turns to a packed schedule of Fed speakers next week for fresh clues about the central bank’s next move.
On the Euro side, traders expect additional tightening from the ECB after the central bank delivered its second rate hike of the year earlier this month. ECB President Christine Lagarde said on Friday that growth is “a bit more promising than we thought” and that policymakers are “not seeing second-round effects yet.” She added that energy is a significant variable and the ECB is well positioned to respond, while stressing that rate decisions will be made “meeting by meeting.”
Analysts at Nordea highlight that “financial market pricing has increased rapidly lately and has already risen considerably above our own baseline forecast of two further 25bp rate hikes from the ECB, one in December and the other in March 2027.” They point out that “rapidly climbing energy prices have been a big driver of rate expectations,” while “uncertainty over what will happen in the Middle East in the coming months remains elevated.”
ECB FAQs
The European Central Bank (ECB) in Frankfurt, Germany, is the reserve bank for the Eurozone. The ECB sets interest rates and manages monetary policy for the region. The ECB primary mandate is to maintain price stability, which means keeping inflation at around 2%. Its primary tool for achieving this is by raising or lowering interest rates. Relatively high interest rates will usually result in a stronger Euro and vice versa. The ECB Governing Council makes monetary policy decisions at meetings held eight times a year. Decisions are made by heads of the Eurozone national banks and six permanent members, including the President of the ECB, Christine Lagarde.
In extreme situations, the European Central Bank can enact a policy tool called Quantitative Easing. QE is the process by which the ECB prints Euros and uses them to buy assets – usually government or corporate bonds – from banks and other financial institutions. QE usually results in a weaker Euro. QE is a last resort when simply lowering interest rates is unlikely to achieve the objective of price stability. The ECB used it during the Great Financial Crisis in 2009-11, in 2015 when inflation remained stubbornly low, as well as during the covid pandemic.
Quantitative tightening (QT) is the reverse of QE. It is undertaken after QE when an economic recovery is underway and inflation starts rising. Whilst in QE the European Central Bank (ECB) purchases government and corporate bonds from financial institutions to provide them with liquidity, in QT the ECB stops buying more bonds, and stops reinvesting the principal maturing on the bonds it already holds. It is usually positive (or bullish) for the Euro.
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