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

EUR/USD trades on the front foot on Wednesday as broad US Dollar (USD) weakness, led by a sharp rally in the Japanese Yen (JPY), supports the pair. At the time of writing, EUR/USD trades around 1.1647, up 0.20% on the day.

The US Dollar Index (DXY), which tracks the Greenback’s value against a basket of six major currencies, trades around 98.65, near its lowest level since August 21. USD/JPY hovers near 153.35, around levels last seen in February, and has fallen about 4% so far this month.

Still, traders avoid placing aggressive bullish bets on EUR/USD ahead of key risk events this week, including the European Central Bank’s (ECB) monetary policy announcement on Thursday and the latest United States (US) inflation data.

Both events come at a crucial time as the war in the Middle East enters its seventh month and keeps energy prices elevated. West Texas Intermediate (WTI) Oil trades around $93.50 per barrel, near its highest level since June 8.

The ECB is widely expected to raise interest rates by 25 basis points (bps) on Thursday, which would mark its second increase this year. The move comes as higher Oil prices add to inflationary pressure across the Eurozone. Headline Harmonized Index of Consumer Prices (HICP) inflation accelerated to 3.3% YoY in August from 2.9% in July.

However, as a quarter-point hike is already fully priced in, the decision itself may draw a limited market reaction. Traders will instead focus on ECB President Christine Lagarde’s press conference for signals on whether policymakers are considering additional rate increases in the coming months.

Analysts at Nomura expect that “we do not forecast further rate hikes from the ECB after September,” the team stresses that “risks to our forecast are skewed squarely towards further hikes due to ongoing tensions in the Middle East,” and adds that “we do not foresee any ECB rate cuts in the coming years.”

On the US side, traders currently price in around a 60% chance of a 25-bps rate hike at next week’s meeting, according to the CME FedWatch Tool. A resilient labour market gives the Federal Reserve (Fed) more room to focus on inflation.

Strategists at Brown Brothers Harriman stress that Friday’s US August CPI release is “the main market driver that will decide the Fed’s September 16 rate decision.” They argue that “a hot CPI print would all but seal a September hike and underpin a firmer USD,” whereas “a cooler reading would strengthen the case for a hold and leave USD vulnerable to a dovish Fed repricing.”

Even so, elevated Oil prices could keep rate hike expectations alive, as Fed officials have repeatedly stressed the need to return inflation to the 2% target. Concerns over persistent price pressures are also reflected in the bond market, with the benchmark 10-year US Treasury yield trading around 4.80%, near its highest level since November 2023.