Euro climbs 0.7% as softer US CPI data weakens dollar

Softer-than-expected US inflation data pushed the dollar lower and drove EUR/USD above $1.1450, as traders pared back bets on Federal Reserve rate hikes.

The euro rose 0.66 percent to $1.1455 on Tuesday after softer-than-expected US inflation data for June tempered expectations for further Federal Reserve tightening, sending the dollar index down 0.6 percent to 100.68.

"The softer-than-expected CPI print undercut the Fed's recent hawkish leanings, sending the dollar lower as markets pared back Fed expectations," said Uto Shinohara, senior investment strategist at Mesirow Currency Management.

The odds of a rate increase at the Fed's July meeting dropped to 12 percent from 42 percent a day earlier, according to CME FedWatch data, though the probability of a hike by year-end remained at 80 percent, down from 89 percent on Monday. Sterling rose 0.53 percent to $1.3417, while the yen gained 0.34 percent to 161.89 per dollar. The euro had traded near $1.1424 on Monday, according to the European Central Bank's official reference rate, before the CPI release pushed it higher.

The relief may prove temporary. The inflation data predates the latest escalation in US-Iran tensions that pushed oil toward $90 a barrel, and Fed Chairman Kevin Warsh, beginning his semiannual testimony to Congress, has warned that anyone expecting the Fed to go soft on inflation would be "disappointed."

Rate Path Uncertainty Caps Dollar Gains

The divergence between near-term and year-end rate expectations reflects the market's struggle to reconcile softer inflation data with persistent geopolitical risks. Federal Reserve Governor Christopher Waller said Monday that rates may need to rise "in the near term" if data shows inflation remaining well above the central bank's 2 percent target.

"The inflation data predates the latest rise in geopolitical tensions, higher oil prices, energy supply risks and Trump's threat of a 20 percent protection fee, meaning the softer headline print does not yet capture these developments," Shinohara said.

Overnight implied volatility for the euro briefly topped 10 percent on Tuesday, a level rarely seen since April, reflecting demand to hedge against large swings in the currency. The euro has oscillated between roughly $1.1350 and $1.1600 over the past several weeks, with the most recent low of $1.1354 hit on June 24.

Yen Holds Near 40-Year Low

The Japanese yen remained under pressure at 161.89 per dollar, hovering near four-decade lows that kept traders on alert for possible intervention from Tokyo. Japan's Finance Minister Satsuki Katayama said the government may consider adjusting state pension fund asset allocations if the environment surrounding asset management changed sharply, comments that briefly strengthened the yen.

Health Minister Kenichiro Ueno told a separate press conference that the ministry would examine reviewing the Government Pension Investment Fund's asset allocation if needed, but downplayed the prospect of any near-term changes. For yen-buying pressure from such a review to be sustained, the allocation increases to domestic assets would need to be at least 5 percentage points in stocks and bonds each, said Masafumi Yamamoto, chief currency strategist at Mizuho Securities.

Without a sustained rise in global energy prices, the US economy is on a modestly disinflationary trajectory that should keep yields and the dollar capped, said Karl Schamotta, chief market strategist at Corpay. The last time the dollar index traded below 101 after a CPI release was in early 2024, preceding a multi-month weakening trend that pushed EUR/USD above $1.1500.

This article is for informational purposes only and does not constitute investment advice.