Euro gains against US Dollar as Middle East tensions ease, US CPI in focus
- EUR/USD rises as hopes for a Middle East peace deal weigh on the US Dollar.
- Traders await Wednesday's US inflation report for fresh clues on the Fed's monetary policy path.
- ECB is expected to raise interest rates on Thursday, but traders want clues on what comes next.
EUR/USD trades on the front foot on Tuesday as tentative signs of de-escalation in the Middle East conflict weigh on safe-haven demand for the US Dollar (USD). Lower Oil prices are also supporting the Euro (EUR), given the Eurozone's heavy reliance on imported energy.
At the time of writing, the pair is trading around 1.1553, recovering from a two-month low of 1.1499 touched on Monday.
US President Donald Trump indicated that the United States and Iran are nearing an agreement to end the war in the Middle East, while Iran and Israel have agreed to halt hostilities. "We're in the final throes of what will be a very, very good deal," Trump told reporters on Tuesday. He added that the Strait of Hormuz would reopen as soon as a deal is finalized.
However, tensions in the Gulf region remain elevated. Israel has continued military operations in Southern Lebanon, while Iran has warned that fighting could resume if Israeli attacks continue. As a result, dips in the US Dollar remain shallow.
The US Dollar Index (DXY), which tracks the Greenback's value against a basket of six major currencies, is trading around 99.89, down 0.12% on the day.
Meanwhile, the Greenback continues to draw support from hawkish Federal Reserve expectations. Traders expect the US central bank could raise interest rates as soon as September, with the probability of a 25-basis-point rate hike standing at around 35%, according to the CME FedWatch Tool.
Attention now turns to the US Consumer Price Index (CPI) report due on Wednesday. Economists expect annual inflation to accelerate to 4.2% in May from 3.8% in April.
The report could provide a fresh signal ahead of next week's Fed meeting, where policymakers are widely expected to leave rates unchanged as inflation continues to drift further away from the central bank's 2% target.
Across the Atlantic, traders are fully pricing in a rate hike at the European Central Bank (ECB) meeting scheduled for Thursday. The bigger question is whether the ECB will leave the door open to further rate increases amid rising stagflation risks across the Eurozone.
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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