Euro Slides as US Dollar Recovers Amid Middle East Tensions

The EUR/USD pair slipped on Monday, reversing earlier gains as market sentiment vacillated between risk‑on and risk‑off attitudes. At the time of writing the pair was trading at about 1.1408, down from an intraday peak of 1.1449.

Developments in the Middle East drove market moves early in the week, with no major economic data to sway sentiment. The euro rose earlier as the US dollar weakened following a Reuters report that mediators had suggested a ten‑day pause in strikes to revive the interim US‑Iran agreement, and officials from both sides signaled openness to diplomacy.

However, caution returned after a separate Reuters report that Yemen’s Iran‑aligned Houthi movement had announced an immediate naval blockade of Saudi Arabia. Traders quickly shifted back to the US dollar, erasing the euro’s earlier advances.

The US Dollar Index (DXY), which measures the dollar against a basket of six major currencies, stood near 101.00, having rebounded from an intraday low of 100.65.

Oil prices have risen to their highest level in over a month as US‑Iran hostilities resumed in early July, keeping energy‑driven inflation concerns in focus and raising the prospect that price pressures could re‑accelerate after easing in both the eurozone and the US during June.

Against this backdrop, markets anticipate that both the European Central Bank (ECB) and the Federal Reserve (Fed) will keep their policy stance tight. The ECB is expected to hold its deposit rate steady at 2.25% on Thursday, though investors are pricing in a rate increase by September. Meanwhile, CME FedWatch indicates a roughly 63% chance of a Fed rate hike in September.

Because the eurozone economy is still operating below its potential, tighter monetary policy is more likely to cap the euro’s decline than to drive it higher, as it raises the chance of lowering ECB rate expectations, analysts at Brown Brothers Harriman (BBH) noted.

ECB FAQs

The European Central Bank (ECB) in Frankfurt, Germany, is the reserve bank for the Eurozone. The ECB sets interest rates and manages monetary policy for the region.
The ECB primary mandate is to maintain price stability, which means keeping inflation at around 2%. Its primary tool for achieving this is by raising or lowering interest rates. Relatively high interest rates will usually result in a stronger 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.

In extreme situations, the European Central Bank can enact a policy tool called Quantitative Easing. QE is the process by which the ECB prints Euros and uses them to buy assets – usually government or corporate bonds – from banks and other financial institutions. QE usually results in a weaker Euro.
QE is a last resort when simply lowering interest rates is unlikely to achieve the objective of price stability. The ECB used it during the Great Financial Crisis in 2009-11, in 2015 when inflation remained stubbornly low, as well as during the covid pandemic.

Quantitative tightening (QT) is the reverse of QE. It is undertaken after QE when an economic recovery is underway and inflation starts rising. Whilst in QE the European Central Bank (ECB) purchases government and corporate bonds from financial institutions to provide them with liquidity, in QT the ECB stops buying more bonds, and stops reinvesting the principal maturing on the bonds it already holds. It is usually positive (or bullish) for the Euro.

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