EUR/USD rises to near yearly high below 1.1050 on concrete prospects of Fed rate cut
- EUR/USD rose slightly to a yearly high of 1.1040 in the early European session on Monday.
- Dovish comments from the Fed and higher bets on a Fed rate cut in September continue to weaken the USD and lift EUR/USD.
- The euro is gaining ground as markets expect the ECB to gradually cut interest rates.
The EUR/USD pair is rising to a yearly high of 1.1040 in the early European session on Monday. The generally weaker US dollar (USD) amid growing speculation that the Federal Reserve (Fed) will cut interest rates in September is offering some support to the major pair. Traders will closely monitor Fed Chair Jerome Powell’s speech on Friday for further clues on possible rate cuts.
San Francisco Fed President Mary Daly said on Sunday that recent US economic data had given her “greater confidence” that inflation was under control. She added that it was time to consider adjusting borrowing costs from their current range of 5.25% to 5.5%. Meanwhile, Chicago Fed President Austan Goolsbee stressed on Sunday that US central bank officials should be cautious not to keep the tight policy in place longer than necessary. The dovish comments from Fed policymakers are putting further selling pressure on the greenback and providing tailwinds for EUR/USD.
Investors are currently pricing in a 70% chance that the Fed will cut interest rates by a quarter of a percentage point in September, while a minority of them expect a half-percentage point cut. Preston Caldwell, chief U.S. economist at Morningstar, noted that the CPI report “provides further support for aggressive Fed rate cuts starting in September.” Caldwell initially expects a 25 basis point cut, which will bring the Fed funds rate to 5.00-5.25%.
Across the pond, the euro (EUR) remains strong as markets expect the European Central Bank (ECB) to cut interest rates gradually. ECB President Christine Lagarde stressed at the last press conference that policymakers “are not committing to a specific interest rate path in advance. There was consensus to pursue a data-dependent and meeting-to-meeting approach.”
Frequently asked questions about the euro
The euro is the currency of the 20 European Union countries that make up the eurozone. It is the second most traded currency in the world after the US dollar, accounting for 31% of all foreign exchange transactions in 2022, with an average daily turnover of over $2.2 trillion per day. EUR/USD is the most traded currency pair in the world, accounting for an estimated 30% of all transactions, followed by EUR/JPY (4%), EUR/GBP (3%) and EUR/AUD (2%).
The European Central Bank (ECB) in Frankfurt, Germany, is the reserve bank of the eurozone. The ECB sets interest rates and manages monetary policy. The ECB’s main mandate is to maintain price stability, which means either controlling inflation or stimulating growth. Its main tool is to raise or lower interest rates. Relatively high interest rates – or the expectation of higher interest rates – usually benefit the euro, and vice versa. The ECB’s Governing Council takes monetary policy decisions at meetings eight times a year. Decisions are made by the heads of the eurozone’s national banks and six permanent members, including ECB President Christine Lagarde.
Inflation data for the euro area, measured by the Harmonized Index of Consumer Prices (HICP), is an important econometric measure for the euro. If inflation rises more than expected, especially above the ECB’s 2% target, the ECB will have to raise interest rates to bring it back under control. Relatively high interest rates compared to counterpart currencies tend to benefit the euro, as they make the region more attractive for global investors to park their money.
Data releases measure the health of the economy and can affect the euro. Indicators such as GDP, purchasing managers’ indices for manufacturing and services, employment and consumer sentiment surveys can all influence the direction of the single currency. A strong economy is good for the euro. Not only does it attract more foreign investment, but it can also encourage the ECB to raise interest rates, which will directly strengthen the euro. Otherwise, if economic data is weak, the euro is likely to fall. Economic data for the four largest eurozone economies (Germany, France, Italy and Spain) are particularly telling, as they account for 75% of the eurozone economy.
Another important data release for the euro is the trade balance. This indicator measures the difference between a country’s export revenues and import expenditures over a given period. If a country produces export goods that are in high demand, its currency will appreciate simply from the additional demand from foreign buyers who want to buy those goods. Therefore, a positive net trade balance strengthens a currency and a negative balance is the opposite.
