Euro weakens as hot US inflation data boosts Fed rate hike expectations

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The Euro (EUR) trades under pressure against the US Dollar (USD) on Wednesday, with EUR/USD extending losses for a second consecutive day as uncertainty surrounding the US-Iran negotiations and hotter-than-expected US inflation data continue to support the Greenback.

EUR/USD trades lower for a second straight day as stronger US inflation data and rising Treasury yields lift the Greenback.
Markets increasingly price in the possibility of a Fed rate hike after US CPI and PPI data topped expectations.
The Euro remains under pressure despite rising ECB rate hike bets as higher energy prices cloud the Eurozone economic outlook.

Rising Oil prices, driven by supply disruptions in the Middle East, continued to feed inflationary pressure at both the consumer and producer levels in the United States (US).

Data released by the US Bureau of Labor Statistics showed that headline Producer Price Index (PPI) inflation rose 6.0% YoY in April, accelerating sharply from 4.3% in March and surpassing market expectations of 4.9%. Meanwhile, core PPI excluding Food and Energy climbed 5.2% YoY from 4.0% previously, also beating forecasts of 4.3%.

The latest figures followed the stronger-than-expected Consumer Price Index (CPI) report released on Tuesday, which showed headline inflation accelerating to 3.8% YoY in April from 3.3% in March, marking the highest reading since May 2023.

The back-to-back upside inflation surprises added pressure on the Federal Reserve (Fed) to maintain a restrictive monetary policy stance as inflation drifts further away from the central bank’s 2% target.

Traders currently anticipate no immediate change in Fed interest rates, but the CME FedWatch tool indicates growing expectations of a rate hike later in the year, with the probability rising to around 38% by December and 52% by January 2027.

The hawkish repricing is pushing US Treasury yields higher and boosting demand for the Greenback. The US Dollar Index (DXY), which tracks the USD against a basket of six major currencies, is trading around 98.50, its highest level in more than a week.

In the Eurozone, growing hawkish bets on the European Central Bank (ECB) are failing to provide meaningful support to the Euro, as rising global energy prices linked to the ongoing Middle East war continue to weigh on the region’s economic outlook.

According to a Reuters poll published on Wednesday, 59 of 70 economists expect the ECB to raise interest rates by 25 basis points in June, while 34 of 70 also expect at least one additional rate hike later this year.

Inflation FAQs

What is inflation?

Inflation measures the rise in the price of a representative basket of goods and services. Headline inflation is usually expressed as a percentage change on a month-on-month (MoM) and year-on-year (YoY) basis. Core inflation excludes more volatile elements such as food and fuel which can fluctuate because of geopolitical and seasonal factors. Core inflation is the figure economists focus on and is the level targeted by central banks, which are mandated to keep inflation at a manageable level, usually around 2%.

What is the Consumer Price Index (CPI)?

The Consumer Price Index (CPI) measures the change in prices of a basket of goods and services over a period of time. It is usually expressed as a percentage change on a month-on-month (MoM) and year-on-year (YoY) basis. Core CPI is the figure targeted by central banks as it excludes volatile food and fuel inputs. When Core CPI rises above 2% it usually results in higher interest rates and vice versa when it falls below 2%. Since higher interest rates are positive for a currency, higher inflation usually results in a stronger currency. The opposite is true when inflation falls.

What is the impact of inflation on foreign exchange?

Although it may seem counter-intuitive, high inflation in a country pushes up the value of its currency and vice versa for lower inflation. This is because the central bank will normally raise interest rates to combat the higher inflation, which attract more global capital inflows from investors looking for a lucrative place to park their money.

How does inflation influence the price of Gold?

Formerly, Gold was the asset investors turned to in times of high inflation because it preserved its value, and whilst investors will often still buy Gold for its safe-haven properties in times of extreme market turmoil, this is not the case most of the time. This is because when inflation is high, central banks will put up interest rates to combat it. Higher interest rates are negative for Gold because they increase the opportunity-cost of holding Gold vis-a-vis an interest-bearing asset or placing the money in a cash deposit account. On the flipside, lower inflation tends to be positive for Gold as it brings interest rates down, making the bright metal a more viable investment alternative.