Euro benefits from weaker US Dollar as ECB decision looms

EUR/USD holds modest gains at the start of North American trading hours on Monday as a softer US Dollar (USD) and stronger-than-expected Eurozone Gross Domestic Product (GDP) data support the Euro (EUR). Trading conditions are expected to stay subdued as US stock and bond markets remain closed for the Labor Day holiday. At the time of writing, the pair trades around 1.1626.

The Greenback stays under pressure as broad Japanese Yen (JPY) strength outweighs support from hawkish Federal Reserve (Fed) expectations and geopolitical tensions. USD/JPY falls to a seven-month low near 154.50, while the US Dollar Index (DXY) hovers near two-week lows around 98.91, down 0.25% on the day.

On the data front, the Eurozone economy expanded 0.6% QoQ in the second quarter, beating the earlier estimate and market forecast of 0.4%. Annual growth was revised higher to 1.2% from 1.0%.

However, the pair’s upside could remain limited ahead of the European Central Bank’s (ECB) monetary policy announcement on Thursday. The ECB is widely expected to raise its Deposit Facility Rate by 25 basis points (bps) to 2.50%, marking its second increase this year, as elevated energy prices due to the war in the Middle East add to inflation concerns.

Strategists at Brown Brothers Harriman note that the upcoming ECB meeting will also see the release of the central bank’s September macroeconomic projections, where they “don’t expect material changes to the Eurozone GDP and inflation forecasts.” They argue that “improving leading economic indicators and slightly softer core inflation are broadly offset by higher energy prices,” leaving the overall outlook little changed.

In their view, the “bottom line” is that “the Eurozone macro backdrop argues in favor of bringing the policy rate closer to the upper end of the ECB’s 1.75%-3.00% neutral range.” BBH adds that “the swaps curve more than fully prices in ECB rates at 3.00% in the next twelve months, which is EUR supportive.”

Tensions rose over the weekend after the US military said it struck three Iranian crude Oil tankers on Saturday in response to Iran firing ballistic missiles at two US Navy ships. The Financial Times also reported that Saudi Aramco’s Jazan refinery was hit by a fresh strike on Monday. West Texas Intermediate (WTI) trades around $90.50 per barrel, close to its highest level since July 24.

Across the Atlantic, US inflation data will be closely watched for clarity on the Fed’s upcoming policy decision, particularly after Friday’s robust employment report. The Producer Price Index (PPI) is due on Thursday, followed by the Consumer Price Index (CPI) on Friday. According to the CME FedWatch Tool, traders currently price in around a 58% chance of a rate hike at the September 15-16 meeting.