Euro consolidates below two-month high as US Dollar steadies
- Euro consolidates below its two-month high as the US Dollar stages a modest recovery.
- US-Iran tensions keep Oil prices elevated and inflation concerns alive.
- Markets expect the Fed to hold rates in September, while the ECB is widely expected to raise borrowing costs.
EUR/USD consolidates losses on Tuesday after pulling back from a two-month high of 1.1614 reached the previous day. A firmer US Dollar (USD) weighs on the Euro (EUR), while traders show a muted reaction to the latest economic releases as market sentiment remains tied to developments in the Middle East and their impact on monetary policy expectations. At the time of writing, the pair trades around 1.1578.
In the United States (US), the four-week average of the ADP Employment Change rose to 9.5K in the week ending August 1 from 8.25K previously. Meanwhile, the Eurozone ZEW Survey showed that Economic Sentiment improved sharply to 31.4 in August from 23.4, beating the market forecast of 25.4.
Despite the stronger Eurozone sentiment reading, the Euro struggles to gain traction as rising US Treasury yields provide some support to the Greenback. The US Dollar Index (DXY), which tracks the US Dollar against a basket of six major currencies, trades around 99.60 after recovering from the two-month low of 99.30 touched on Monday.
Still, the US Dollar’s strength appears limited in the near term as a run of weaker US economic data prompts traders to scale back Federal Reserve (Fed) rate-hike expectations. According to the CME FedWatch Tool, markets now see around a 65% probability that the Fed will leave interest rates unchanged next month, compared with earlier expectations for a hike.
Nevertheless, the US-Iran standoff over the Strait of Hormuz keeps the inflation outlook uncertain. US President Donald Trump said Washington is not seeking an extension of the memorandum of understanding with Iran, which expired on Monday, reducing hopes for a peace agreement and the reopening of the key waterway in the near term.
Elevated Oil prices raise the risk that inflation stays above the Fed’s 2% target for longer, preventing markets from fully ruling out a rate hike later this year. Meanwhile, the European Central Bank (ECB) is widely expected to raise interest rates in September.
ECB Chief Economist Philip Lane said on Tuesday that Eurozone inflation running “one percentage point above the ECB’s 2% target is a lot” and expects it to “hover around the 3% level for the rest of the year.”
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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