Euro climbs as fading Fed hike expectations pressure US Dollar

On Friday, the Euro (EUR) climbed higher, recovering the losses it had incurred earlier in the week. This movement was driven by the overall weakening of the US Dollar (USD), which in turn lifted the Euro. The EUR/USD pair reached approximately 1.1580, marking its highest level since June 17. The US Dollar's decline stemmed from recent U.S. economic data that doused expectations of an imminent Federal Reserve (Fed) interest-rate hike.

The US Dollar Index (DXY), which gauges the Greenback's strength against a basket of six major currencies, saw a slight dip to 99.50, down 0.47% for the day. US Retail Sales in July fell by 0.6%, falling short of the anticipated 0.1% increase. The University of Michigan (UoM) reported that the Consumer Sentiment Index dipped to 51.0 in August from 55.2, while the Consumer Expectations Index declined to 50.6 from 55.4.

This follows a series of recent Consumer Price Index (CPI) and Producer Price Index (PPI) reports, which indicated easing price pressures for the second consecutive month. This suggests that the inflationary effects of the recent energy shock are diminishing. The CME FedWatch Tool now suggests a 70% probability that the Fed will keep interest rates steady in September, a significant shift from earlier expectations of a rate increase.

However, inflation concerns are still leaning towards the higher side, as the reopening of the Strait of Hormuz remains uncertain and keeps oil prices elevated. The Michigan survey's one-year inflation expectation rose to 4.3% from 4.2%, whereas the five-year measure remained unchanged at 3.3%. Euro market participants widely anticipate the European Central Bank (ECB) to raise interest rates in September, marking its second hike of the year.

Commerzbank economists predict the ECB's September move could bring the deposit rate to 2.5%, which they consider the upper limit of the neutral interest rate. This rate would neither stimulate nor slow the economy and maintain medium-term inflation at a medium-term inflation. Looking ahead, Commerzbank believes that the ECB may lower interest rates again by the end of 2027, as inflation is expected to gradually decline throughout the year and approach the inflation target.

The European Central Bank (ECB) in Frankfurt, Germany, is the monetary authority responsible for setting interest rates and managing monetary policy in the Eurozone. The ECB's primary goal is to maintain price stability, which means keeping inflation close to 2%. The ECB achieves this objective by raising or lowering interest rates.

In extreme situations, the ECB can use a policy tool called Quantitative Easing (QE), where it prints Euros and buys assets like government or corporate bonds from banks and financial institutions. QE typically results in a weaker Euro. Conversely, Quantitative Tightening (QT) is the opposite of QE. It occurs when the ECB stops buying more bonds and ceases reinvesting maturing bonds. QT is generally positive for the Euro.