Euro benefits from broad US Dollar weakness ahead of ECB rate decision

On Wednesday, the Euro (EUR) enjoyed gains as the US Dollar (USD) experienced a decline, bolstered by a surge in the Japanese Yen (JPY). By the time of reporting, EUR/USD was trading around 1.1647, marking a 0.20% increase for the day. The US Dollar Index (DXY) hovered near 98.65, close to its lowest point since August 21. Simultaneously, USD/JPY settled close to 153.35, near levels observed in February, with a 4% decrease this month.

However, experts refrain from making aggressive bullish predictions on EUR/USD before key events this week, such as the European Central Bank's (ECB) monetary policy decision on Thursday and the latest US inflation data. These events hold particular significance due to the ongoing Middle East conflict and the recent spike in energy prices, with West Texas Intermediate (WTI) Oil near $93.50 per barrel, a high not seen since June 8.

The ECB is expected to raise interest rates by 25 basis points (bps) on Thursday, potentially marking two increases this year, amid rising oil prices fueling inflation in the Eurozone. The Harmonized Index of Consumer Prices (HICP) inflation rose to 3.3% year-on-year in August, up from 2.9% in July. Nonetheless, as a quarter-point hike is already anticipated, the decision may elicit a modest market response.

Traders will likely pay closer attention to ECB President Christine Lagarde's press conference for indications on potential additional rate hikes. Nomura analysts project that "we do not foresee further rate hikes from the ECB after September," stressing that "risks to our forecast are predominantly weighted towards further hikes due to ongoing Middle East tensions," while dismissing any expectation of rate cuts from the ECB in the near future.

Meanwhile, in the US, a 60% probability of a 25-bps rate increase at the upcoming meeting is priced in, according to the CME FedWatch Tool. A robust labor market provides the Federal Reserve (Fed) with more room to concentrate on inflation. Brown Brothers Harriman strategists highlight that the US August CPI release on Friday will be the primary market driver influencing the Fed's September 16 rate decision.

A strong CPI read would strongly suggest a September hike and strengthen the USD, while a cooler reading could support a hold and potentially weaken the USD. Elevated oil prices might sustain rate hike expectations, as Fed officials have repeatedly emphasized the need to bring inflation back to the 2% target. This sentiment is echoed in the bond market, with the benchmark 10-year US Treasury yield near 4.80%, close to its highest level since November 2023.