Euro Edges Up as Dollar Weakness Offers Support

The euro edged back above $1.16, pausing its recent selloff as a sharp rally in the yen weighed on the US dollar and easing oil prices offered some relief. The yen strengthened on growing expectations of a Bank of Japan rate hike and the possibility of official intervention, triggering broad-based dollar weakness. Meanwhile, Brent crude retreated from six-week highs after US President Donald Trump said the renewed US military campaign in Iran would not last long. The euro nevertheless remains near a two-week low amid concerns over energy-driven inflation, higher interest rates and fiscal sustainability in countries including France and the UK. Money markets continue to fully price in a 25-basis-point ECB rate hike to 2.5% next week. Markets are also pricing in an almost 100% probability of a 3% deposit rate by June 2027, implying two further rate increases by mid-2027.

The euro remained little changed just below $1.16, hovering near a two-week low, as investors moved away from riskier assets amid concerns over the economic impact of the energy shock from renewed hostilities in the Middle East. Brent crude climbed to fresh six-week highs as traders weighed persistent risks to supply against signs that oil was still reaching global markets. Meanwhile, Eurozone inflation data released earlier this week showed price growth at its highest level in nearly three years, reinforcing expectations for further ECB tightening. Money markets are now pricing in almost a 100% probability of a rate hike next week, with another increase by year-end also seen as likely. ECB policymakers Olli Rehn and Martin Kocher warned that a prolonged conflict and rising inflation risks could warrant further tightening. In the US, markets are pricing in a 66% probability of a September rate hike following hawkish remarks from Fed Chair Kevin Warsh and a renewed rise in oil prices.

The euro weakened slightly below $1.16, as investors assessed the latest Eurozone inflation data and its implications for the ECB’s rate outlook. Annual inflation rose to 3.3% in August, its highest level since September 2023 and well above the ECB’s 2% target, driven largely by a surge in energy prices amid continued fighting in the Middle East. The data reinforced expectations of an ECB rate hike as soon as this month, despite easing services and core inflation. Markets are now pricing the deposit rate at around 2.70% by December, implying roughly an 80% probability of a second hike following an expected September move. ECB policymaker Olli Rehn warned that a prolonged conflict could keep inflation elevated, while Martin Kocher said rising inflation risks could require a swift rate hike if confirmed in the ECB’s next forecasts. Meanwhile, the dollar remained supported after Fed Chair Kevin Warsh struck a hawkish tone, with markets pricing a 68% probability of a September Fed hike.