EUR/USD extends losses as geopolitical risks keep USD firmly bid
- EUR/USD extends losses as US-Iran tensions keep the Dollar broadly supported.
- Markets now expect the Federal Reserve to hold rates through 2026 amid persistent inflation risks.
- The European Central Bank faces pressure as higher energy costs threaten Eurozone growth.
The Euro (EUR) edges lower against the US Dollar (USD) on Thursday, with EUR/USD extending losses for a third consecutive session as ongoing geopolitical tensions surrounding the US-Israel war with Iran keep the Greenback firmly bid across the board. At the time of writing, the pair trades near 1.1529, down around 0.26% on the day.
The war is expected to drag on after Iran rejected a proposed 15-point plan from the United States aimed at ending the conflict, saying any agreement must be on its own terms, including security guarantees and recognition of its authority over the Strait of Hormuz.
The Strait of Hormuz remains effectively closed, with the conflict continuing to embed a geopolitical risk premium in Oil prices. This is fueling global inflation concerns and could prompt major central banks to keep interest rates higher for longer or even consider raising rates if Oil prices remain elevated.
Markets now expect the Federal Reserve (Fed) to keep interest rates on hold through 2026, with the central bank already navigating a difficult policy backdrop. Inflation remains above the 2% target, with renewed upside risks, while labor market risks are tilted to the downside, putting both sides of the Fed’s dual mandate under pressure.
In this environment, the Fed is likely to remain data-dependent, keeping policy restrictive for longer to contain inflation while closely monitoring signs of weakness in the labor market before considering any adjustments.
The European Central Bank (ECB) is also in a difficult position. While inflation is relatively contained near the 2% target, the Eurozone’s reliance on energy imports makes it more exposed to higher Oil prices, which are expected to weigh on growth and household spending.
Market pricing has shifted sharply, with two rate hikes now fully priced in versus earlier expectations of a hold, and April increasingly seen as the likely timing for the first rate hike.
Supporting this view, ECB policymaker Joachim Nagel said, “An April rate hike is certainly an option, but just one option,” adding, “We will have enough data by April to determine if we need to act or if we can wait and see.”
On the data front, recent economic releases this week have pointed to a slowdown in the Eurozone economy. Germany’s GfK Consumer Confidence for April fell to -28, missing expectations, while the Ifo Business Climate index dropped to a 13-month low of 86.4 in March.
Recent Purchasing Managers Index (PMI) data also showed business activity losing momentum, reinforcing concerns about weaker growth.
Inflation FAQs
Inflation measures the rise in the price of a representative basket of goods and services. Headline inflation is usually expressed as a percentage change on a month-on-month (MoM) and year-on-year (YoY) basis. Core inflation excludes more volatile elements such as food and fuel which can fluctuate because of geopolitical and seasonal factors. Core inflation is the figure economists focus on and is the level targeted by central banks, which are mandated to keep inflation at a manageable level, usually around 2%.
The Consumer Price Index (CPI) measures the change in prices of a basket of goods and services over a period of time. It is usually expressed as a percentage change on a month-on-month (MoM) and year-on-year (YoY) basis. Core CPI is the figure targeted by central banks as it excludes volatile food and fuel inputs. When Core CPI rises above 2% it usually results in higher interest rates and vice versa when it falls below 2%. Since higher interest rates are positive for a currency, higher inflation usually results in a stronger currency. The opposite is true when inflation falls.
Although it may seem counter-intuitive, high inflation in a country pushes up the value of its currency and vice versa for lower inflation. This is because the central bank will normally raise interest rates to combat the higher inflation, which attract more global capital inflows from investors looking for a lucrative place to park their money.
Formerly, Gold was the asset investors turned to in times of high inflation because it preserved its value, and whilst investors will often still buy Gold for its safe-haven properties in times of extreme market turmoil, this is not the case most of the time. This is because when inflation is high, central banks will put up interest rates to combat it. Higher interest rates are negative for Gold because they increase the opportunity-cost of holding Gold vis-a-vis an interest-bearing asset or placing the money in a cash deposit account. On the flipside, lower inflation tends to be positive for Gold as it brings interest rates down, making the bright metal a more viable investment alternative.
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