The pair’s advance reflects a sharp repricing of monetary policy expectations. Markets now see around a 70% chance that the Federal Reserve will keep interest rates unchanged in September, a stark reversal from earlier expectations of an increase. Meanwhile, the European Central Bank (ECB) is widely anticipated to deliver its second ECB rate hike of the year next month.
US Retail Sales Miss Targets, Weighing on US Dollar
The US Dollar Index (DXY), which tracks the Greenback against a basket of six major currencies, slipped to around 99.50, down 0.47% on the day. The broad-based weakness followed a barrage of soft economic data that tempered expectations for a near-term Federal Reserve interest-rate hike. US Retail Sales fell by 0.6% in July, significantly missing expectations for a 0.1% increase and reversing the previous month’s 0.2% gain.
Consumer sentiment data compounded the dollar’s weakness. Preliminary figures from the University of Michigan (UoM) showed that the Consumer Sentiment Index fell to 51.0 in August from 55.2. The Consumer Expectations Index dropped to 50.6 from 55.4. These figures followed this week’s Consumer Price Index (CPI) and Producer Price Index (PPI) reports, which indicated that price pressures eased for a second consecutive month, suggesting the inflationary impact of the recent energy shock is fading.
The combination of weakening consumer demand and easing wholesale and consumer prices provides the Federal Reserve with the breathing room needed to assess the lagged effects of its previous tightening cycle. With inflation showing tangible signs of cooling, the central bank’s mandate to restore price stability is facing less immediate pressure, allowing policymakers to pivot toward sustaining maximum employment amid a slowing economy.
Divergent Central Bank Paths Drive EUR/USD Rally
While the Federal Reserve may be nearing a pause, the ECB appears poised to continue tightening monetary policy. Economists at Commerzbank expect the next ECB rate hike in September to bring the deposit rate to 2.5%. At this level, “a level would be reached that Governing Council members view as the upper limit of the neutral interest rate—one that neither stimulates nor slows the economy and leads to medium-term inflation.”
Reaching the neutral rate threshold would mark a critical milestone for the ECB. It would signal that the central bank has withdrawn all accommodation and is no longer stimulating the Eurozone economy. This transition from aggressive tightening to a more measured, data-dependent approach provides structural support for the Euro, as capital markets price in the end of the ECB’s hiking cycle.
Looking further ahead, Commerzbank argues that “toward the end of 2027, the ECB is likely to lower interest rates again,” as “inflation should gradually decline over the course of the coming year and come close to reaching the inflation target.” This forward guidance establishes a long-term framework for Euro valuation, suggesting that while near-term rate hikes will bolster the currency, eventual policy easing could cap sustained upward momentum.
What Happens Next
Despite the broad-based US Dollar weakness, inflation risks remain tilted to the upside. Uncertainty over the reopening of the Strait of Hormuz continues to keep Oil prices elevated, which could rekindle price pressures across the global economy. The Michigan survey’s one-year inflation expectation edged up to 4.3% from 4.2%, while the five-year measure held steady at 3.3%, indicating that consumers still anticipate elevated costs over the medium term.
Traders will closely monitor upcoming Federal Reserve speeches and the next round of US labor market data to confirm whether the central bank will truly hold rates steady. If energy prices spike and force inflation higher, the Fed could be forced back into a hiking posture, which would rapidly unwind the current EUR/USD rally. Conversely, if the ECB delivers its expected hike and signals a prolonged pause, the pair could consolidate its gains above the 1.15 threshold.
The next major catalyst for the pair will be the Federal Reserve’s Jackson Hole symposium and subsequent inflation prints. Any hawkish pushback from Fed officials against market pricing of a rate pause could trigger a sharp correction in EUR/USD, while further deterioration in US economic data could accelerate the dollar’s decline and push the pair toward yearly highs.
— Hiro Tanaka, markets desk, AXO News