Commerzbank’s Volkmar Baur notes that EUR/USD has fallen to around 1.16 as markets now price a higher probability of a Fed rate hike by year-end while expecting the European Central Bank (ECB) to react less to inflation. Diverging PMI data show the Eurozone economy is hit harder by higher Oil and gas prices than the US, leaving EUR/USD sensitive to developments in the Iran conflict.

Diverging Fed and ECB reactions on Oil

"After all, the oil price is only a few bucks higher, and EUR/USD sits significantly lower at 1.16."

"The market therefore assumes that the ECB will not react as strongly to rising inflation as it did two weeks ago. And overall, this explains the lower EUR-USD rate."

"The eurozone economy is being hit much harder by higher oil and gas prices than the US economy. And this limits the ECB’s room to maneuver in responding to higher inflation more than the US economy limits the Fed."

"Looking ahead, this underscores once again how important the further course of the Iran conflict remains for EUR/USD. A swift resolution would certainly support the euro, as the market would likely price in Fed rate cuts again and the movement in rate expectations would probably be greater in the US than in the eurozone."

"Conversely, recent developments suggest that if the conflict persists, the euro is likely to lose ground against the US dollar over time as it becomes clearer that the economic impact in Europe is more severe than in the US."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor.)