Euro weakens for third day as Fed hike repricing eclipses German IFO improvement

• The Euro extends its decline for a third consecutive day against the US Dollar.
• Markets continue to increase expectations for a Fed rate hike later this year.
• Germany’s IFO survey points to a gradual improvement in business sentiment, while the ECB remains cautious on inflation prospects.

EUR/USD extends its decline on Wednesday and trades around 1.1340 at the time of writing, down 0.39% on the day, as the US Dollar (USD) benefits from renewed support driven by expectations of additional monetary tightening in the United States (US). The move follows last week’s Federal Reserve (Fed) meeting, which signaled a more hawkish stance from policymakers amid persistent inflationary pressures.

The US Dollar remains supported by a repricing of interest rate expectations. The Fed’s projections released last week showed that a growing number of policymakers now see the need for higher rates before year-end. According to the CME FedWatch tool, investors assign a high chance to a rate hike over the coming months, continuing to underpin the Greenback.

This dynamic keeps the US Dollar Index (DXY), which measures the Greenback against a basket of six major currencies, near its highest levels in more than a year, adding further pressure on the Euro (EUR).

On the European side, economic data provided some encouraging signals. Germany’s IFO Business Climate Index rose to 85.6 in June from 85 previously, matching expectations. The Current Assessment Index exceeded forecasts, while the Expectations Index also improved modestly. The figures confirm a gradual recovery in confidence within the Eurozone’s largest economy.

Commerzbank noted that the German economy could still post weak or even slightly negative growth in the second quarter due to the impact of previously elevated energy prices. However, the bank believes the latest IFO survey offers encouraging signs for a moderate recovery in the second half of the year.

Comments from the European Central Bank (ECB) have also limited support for the single currency. ECB Chief Economist Philip Lane stated that uncertainty remains elevated despite improving geopolitical prospects in the Middle East and warned that inflation could stay above the 2% target until the first half of 2027. His remarks reinforce expectations that the ECB will maintain a cautious approach in the coming months.

Analysts at Scotiabank highlighted that the widening yield differential between US and Eurozone Bonds continues to weigh on the Euro. The bank argues that the recent hawkish repricing of Fed expectations, while ECB expectations remain broadly unchanged, represents a key bearish factor for EUR/USD in the near term.

Investors are now awaiting Thursday’s release of the US Personal Consumption Expenditures (PCE) Price Index, the Fed’s preferred inflation gauge. The report could provide fresh guidance on the outlook for US monetary policy and help determine the next direction for EUR/USD.