Euro climbs to 1.1580 as fading Fed hike bets weaken dollar

EUR/USD rallied to 1.1580 on Friday, erasing the week's losses as soft US retail sales and inflation data pushed markets to price a 70 percent chance the Federal Reserve holds rates in September.

"This may give the illusion of a buoyant EUR," Rabobank analysts said. "The move, however, was driven mostly by the USD."

US Retail Sales fell 0.6 percent in July, missing the 0.1 percent gain forecast and reversing the prior month's 0.2 percent rise. The University of Michigan's Consumer Sentiment Index dropped to 51.0 in August from 55.2, while the Consumer Expectations Index slid to 50.6 from 55.4. The US Dollar Index traded near 99.50, down 0.47 percent on the day.

The repricing follows two consecutive months of cooling CPI and PPI readings, suggesting the inflationary shock from higher energy prices is fading. Markets now see roughly a 70 percent chance the Fed holds rates in September, a sharp reversal from earlier hike expectations, while the European Central Bank is widely expected to raise its deposit rate to 2.5 percent next month.

Rate Differentials Narrow as Fed, ECB Diverge

The divergence in policy paths is the core driver of the euro's climb. Rabobank expects the Fed to leave rates unchanged this year, a view that "suggests scope for further softness in the USD." The bank brought forward its EUR/USD forecast of 1.16 from six months to three months. But it cautioned against reading the move as broad euro strength — the single currency sits around the middle of the G10 pack over the past week and remains the third-worst performer year-to-date.

The catalyst was the unexpectedly weak US July payrolls report, which "dealt a blow to expectations of Fed rate hikes which knocked US yields and the greenback lower," Rabobank said. The July PPI report, released this week, showed wholesale prices unchanged month-over-month, with core PPI up 0.2 percent — further evidence that price pressures are easing after the CPI report pointed to a slower-than-expected rise.

Eurozone Resilience Meets Export Headwinds

Europe has held up better than expected. Eurozone GDP grew 0.4 percent quarter-on-quarter in Q2, twice the consensus forecast, while the July composite PMI rose to 51.9 from 50.0. Yet Germany's unemployment rate rose to 6.4 percent in July, and softer real compensation growth suggests household spending could stagnate through the rest of the year. A stronger euro is not necessarily welcome for exporters already facing weak external demand and intense Chinese competition.

Commerzbank economists expect the ECB's September move to bring the deposit rate to 2.5 percent, a level they view as the upper limit of the neutral rate — one that neither stimulates nor slows the economy. Toward the end of 2027, they expect the ECB to lower rates again as inflation gradually declines toward target. Rabobank, meanwhile, doubts the market will rebuild substantial euro longs in the absence of upside growth surprises in Q3, noting that another ECB hike is already priced in and unlikely to provide much additional upside incentive for the euro.

The dollar's slide has implications beyond EUR/USD. A weaker greenback lifted gold toward $4,400 on Friday and eases pressure on emerging-market currencies, while multinationals see a boost to the translation value of overseas earnings. The next test comes at the Fed's September meeting, where the rate decision and updated projections will determine whether the euro extends toward 1.16 or stalls.

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