The European Central Bank’s rate increase and its confident outlook on the economy and inflation proved insufficient to counteract the impact of accelerating US producer price growth and the sell-off in government bonds. The US dollar staged a strong recovery as expectations for Federal Reserve rate hikes were revised upward. Although the ECB’s policy tightening served as a notable headwind for EURUSD, it ultimately failed to halt the dollar’s advance, as markets remained fixated on the surge in producer prices and the Treasury’s inability to suppress the rally in yields through buybacks. The actual buyback figure came in at $5.3 billion, below the announced $6 billion. Despite Scott Bessent’s assertions that the debt market remains in strong shape, yields continue to climb, posing a threat to equity indices and dampening appetite for risk assets.
The ECB met expectations by raising the deposit rate from 2.25% to 2.5%. Inflation and GDP forecasts were revised slightly upwards, enabling money markets to fully price in an end-of-year rate hike to 2.75%, up from 2.68% previously. However, Bloomberg notes that monetary policy tightening could materialize in either October or December, when forecasts are next updated.
Christine Lagarde’s rhetoric was decidedly hawkish, as reflected in the upward revision of long-term rate expectations. Nevertheless, in the short term, the impact on EURUSD was eclipsed by US inflation figures and the outlook for Fed monetary policy, which the market prioritizes above all else. At the same time, the European Central Bank’s emphasis on a data-dependent approach was interpreted as a reluctance to signal a continuation of the tightening cycle—suggesting, at the very least, a pause intended to assess conditions before committing to the next move.
US producer price data ignited demand for the dollar. The headline PPI rose by 0.4% m/m, accelerating the annual rate to 5.4% y/y. The progress achieved on inflation in recent months has been effectively reversed, confirming concerns previously raised by Kevin Warsh at Jackson Hole. The pronounced reaction to the PPI figures prompted a reassessment, with expectations for the CPI release—scheduled for Friday and serving as the last key data point ahead of the FOMC meeting—being revised upward. Consequently, the probability of a Fed rate rise in September has climbed from 60% to 70%, while the likelihood of two rounds of monetary tightening in 2026 has increased from 49% to 63%.
A significant acceleration in US consumer prices and core inflation beyond the forecasted 3.4% and 2.4%, respectively, would solidify expectations of a rate hike at the FOMC meeting on 15–16 September, potentially driving further gains in the US dollar index. Thereafter, market attention will shift to the 3–9 month rate outlook, which the rate statement and press conference are expected to influence.
