Euro declines as risk aversion, Fed rate hike odds increase
- EUR/USD depreciates as the US Dollar rises on the Fed shifting toward a more aggressive inflation stance.
- Fed officials prioritized controlling inflation, suggesting further interest rate hikes remain necessary if price pressures persist.
- The Euro may rise due to hawkish European Central Bank policy expectations.
EUR/USD remains subdued for the sixth successive day, trading around 1.1620 during the Asian hours on Monday. The pair loses ground as the US Dollar (USD) rises on the US Federal Reserve (Fed) shifting toward a more aggressive policy stance on inflation.
Several Fed officials recently emphasized that controlling inflation is their top priority, even suggesting that further interest rate hikes could be necessary if price pressures persist. Financial markets have sharply increased the likelihood of a December rate hike to nearly 48%, up significantly from just 14% a week prior, according to the CME FedWatch tool.
The Greenback also receives support from increased safe-haven demand amid ongoing geopolitical conflicts. The United States (US) and Iran remain far from an agreement to end weeks of fighting and reopen the critical Strait of Hormuz shipping route.
US President Donald Trump escalated tensions by publicly warning Iran to make progress or face new consequences. Because the Strait remains effectively closed, global oil prices are continuing to climb, which places a heavy economic burden on countries that rely heavily on energy imports. Global investor anxiety is heightened further by warnings from Chinese leader Xi Jinping to President Trump that Taiwan could trigger direct clashes between their two economies.
However, the downside of the EUR/USD pair could be restrained as the Euro (EUR) may gain ground amid hawkish sentiment surrounding the European Central Bank (ECB) policy outlook.
ECB policymakers hinted at an interest rate hike to tame sticky inflation expectations. A Reuters poll suggested that the 85% of economists indicated that the central bank would raise its deposit rate by 25 basis points (bps) to 2.25% in June, up from just over half expecting that before the April meeting.
Euro FAQs
The Euro is the currency for the 20 European Union countries that belong to the Eurozone. It is the second most heavily traded currency in the world behind the US Dollar. In 2022, it accounted for 31% of all foreign exchange transactions, with an average daily turnover of over $2.2 trillion a day. EUR/USD is the most heavily traded currency pair in the world, accounting for an estimated 30% off 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 for the Eurozone. The ECB sets interest rates and manages monetary policy. The ECB’s primary mandate is to maintain price stability, which means either controlling inflation or stimulating growth. Its primary tool is the raising or lowering of interest rates. Relatively high interest rates – or the expectation of higher rates – will usually benefit the Euro and vice versa. The ECB Governing Council makes monetary policy decisions at meetings held eight times a year. Decisions are made by heads of the Eurozone national banks and six permanent members, including the President of the ECB, Christine Lagarde.
Eurozone inflation data, measured by the Harmonized Index of Consumer Prices (HICP), is an important econometric for the Euro. If inflation rises more than expected, especially if above the ECB’s 2% target, it obliges the ECB to raise interest rates to bring it back under control. Relatively high interest rates compared to its counterparts will usually benefit the Euro, as it makes the region more attractive as a place for global investors to park their money.
Data releases gauge the health of the economy and can impact on the Euro. Indicators such as GDP, Manufacturing and Services PMIs, 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 may encourage the ECB to put up 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 economies in the euro area (Germany, France, Italy and Spain) are especially significant, as they account for 75% of the Eurozone’s economy.
Another significant data release for the Euro is the Trade Balance. This indicator measures the difference between what a country earns from its exports and what it spends on imports over a given period. If a country produces highly sought after exports then its currency will gain in value purely from the extra demand created from foreign buyers seeking to purchase these goods. Therefore, a positive net Trade Balance strengthens a currency and vice versa for a negative balance.