Euro Strengthens Near 1.1385 as ECB Signals Possible September Rate Hike

The EUR/USD pair gains ground to approach 1.1385 during early European trading on Friday, supported by growing expectations of another European Central Bank (ECB) rate increase. Friday’s highlights include preliminary Purchasing Managers Index (PMI) readings for July from the Eurozone, Germany, and the United States.

The ECB decided to leave key interest rates unchanged at its July policy meeting on Thursday, as widely anticipated, but left the door open for another hike in September. A sharp rise in energy prices has raised concerns that inflation will remain substantially above the bank’s 2% target.

ECB President Christine Lagarde stated during a press conference that the central bank expects inflation to stay “well above target” until the first half of 2027. Officials remain vigilant against a potential “second-round inflation shock” triggered by the ongoing US-Iran conflict, with markets generally anticipating that rate hikes will resume later this year.

Hawkish ECB expectations could provide near-term support to the Euro (EUR) against the US Dollar (USD). According to Reuters, markets are currently pricing in roughly a 95% probability of a 25-basis-point ECB rate hike in September and a similar chance of an additional move by December.

The US military conducted a 13th consecutive night of strikes on Iran, targeting drone installations and coastal surveillance sites. US President Donald Trump warned on Thursday that the US would hold Iran accountable for the Houthi actions and that both Iran and its Houthi allies would soon face a “major military punishment,” as reported by the Guardian. Escalating tensions in the Middle East could bolster the US dollar as a safe-haven asset, creating a headwind for the pair.

Eurozone Short-End Yields Lead as Markets Reposition for Hawkish ECB and Fed Paths

Analysts at MUFG note that “in response to rising energy prices, market participants have been adjusting to more hawkish expectations for major central banks, including the ECB and the Fed, driving short-term yields to fresh year-to-date highs.” They observe that “the euro-zone rate market is now pricing in two to three further ECB rate hikes over the coming year, while the US rate market is pricing in around two Fed hikes over the same period.” MUFG adds that “short-term yields have risen more recently in Europe than in the US, causing yield spreads to move against the USD,” highlighting how the recent repricing has been more pronounced on the Eurozone side of the curve.

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