Dollar soars as US inflation remains persistent

Important calendar events

• JPY: Tertiary Industry Activity
• EUR: French Final CPI, Italian Trade Balance, Trade Balance,
• GBP: Consumer Inflation Expectations
• USD: Empire State Manufacturing Index, Import Prices, Industrial Production, Capacity Utilization Rate, Preliminary UoM Consumer Sentiment, Preliminary UoM Inflation Expectations

USD

The dollar soared on Thursday as US inflation continued to rise, and the dollar index was catapulted to 105.2. US Treasury yields were stable, with the US 10-year bond yield climbing above 4.28%. 

Sticky US inflation has boosted the dollar this week. PPI data on Thursday confirmed that inflationary pressures are not easing just yet, despite the Fed’s high interest rates. PPI rose by 0.7% in August, exceeding expectations of a 0.4% raise. Core PPI, which excludes food and energy, decelerated a little, rising by 0.2% in August compared to a 0.4% growth in July. Rising fuel costs are largely to blame for the stubbornly high inflation rates in the US. 

Consumer inflation is also accelerating, with CPI rising by 0.3% in August from 0.2% in July against expectations of a 0.2% print. Headline inflation came in hotter than anticipated, climbing to 3.7% year-on-year in August from 3.2% in July versus 3.6% anticipated. Core inflation, which excludes food and energy, also rose by 0.3% in August from 0.2% in July. Increasing price pressures may push the Fed to continue its hawkish policy until inflation drops closer to the Fed’s 2% target.

The dollar is expected to be driven in the next few weeks by Fed rate hike expectations. The U.S. Federal Reserve raised interest rates by 25 basis points in July to a target range of 5.25% to 5.50%, the highest level in 22 years. 

The Fed’s aggressively hawkish policy over the past year has been paying off and inflationary pressures in the US are easing. Most investors are anticipating a pause in rate hikes, but the US central bank has signaled that further tightening is possible if inflation does not go down consistently. Markets are expecting a pause in rate hikes this month but market odds of another rate hike in November are increasing.

Preliminary GDP for the second quarter of 2023 showed that the US economy expanded by only 2.1% against expectations of 2.4% growth. The preliminary GDP price index for the 2nd quarter of the year also came in below expectations at 2.0% versus 2.2% anticipated.

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EUR

EUR/USD plummeted on Thursday, dropping to the 1.065 level. If the EUR/USD pair declines, it may find support at 1.060, while resistance may be encountered near 1.080. 

The ECB raised interest rates by 25 bp at its monetary policy meeting on Thursday, bringing its main refinancing rate to 4.50%. The ECB had the difficult task of assessing the risk to the fragile Eurozone economy against high inflation rates. In the end, persistently high inflation induced the central bank to raise interest rates again on Thursday. 

The rate hike was not fully priced in, as the market's odds were split between a 25-bp rate hike and a pause in a rate hike. Nevertheless, the Euro dropped sharply on Thursday as the ECB hinted that it had reached its interest rate ceiling. Most market analysts believe that the ECB has reached its terminal rate. ECB President Christine Lagarde signaled an end to rate hikes at the press conference after the conclusion of the meeting. Lagarde warned, however, that interest rates will remain at sufficiently restrictive levels for as long as necessary.

Flash CPI data for August showed that Euro Area headline inflation remained unchanged at 5.3% year-on-year against expectations of a drop to 5.1%. Core CPI, which excludes food and energy, however, dropped to 5.3% from 5.5% in July. 

Final GDP data for the Euro area were disappointing, showing that the Eurozone economy expanded by only 0.1%, in the second quarter of the year, against expectations of 0.3% growth. The Eurozone economy barely expanded in the second quarter after contracting by 0.1% in Q1 of 2023. The EU economy is struggling and cannot withstand much further tightening. 

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GBP

The Sterling weakened on Thursday as the rivaling dollar gained strength and GBP/USD dropped to 1.240. If the GBP/USD rate goes up, it may encounter resistance near 1.258, while support may be found near 1.231. 

RICS House Price Balance data on Thursday showed British house prices had the most widespread falls in 14 years in August. Housing demand in the UK dropped due to elevated mortgage costs and economic uncertainty.

Britain’s economy contracted by 0.5% month-on-month in July after expanding by 0.5% in June. The prognosis was more optimistic, with markets forecasting a 0.2% decline in GDP. The state of the British economy is fragile, as prolonged tightening has taken its toll on the labor market and other vital economic sectors. The British economy weakened more than expected in July and this may play a decisive role in the BOE’s monetary policy decision next week.

The BOE raised interest rates by 25 basis points at its latest policy meeting, bringing the bank rate to a 15-year high of 5.25%. Market odds are in favor of another 25-bp rate hike in September followed by another in November.

High inflation in the UK is putting pressure on BOE policymakers to increase interest rates. Inflation in the UK is showing signs of cooling, demonstrating the effectiveness of the BOE’s consistently hawkish policy. Headline inflation dropped to 6.8% year-on-year in July from 7.9% in June. Core CPI, which excludes food and energy, remained steady at 6.9%. Even though inflationary pressures in the UK are easing, inflation is still high, and policymakers are likely to continue raising interest rates to bring it down. 

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JPY

The Yen traded sideways against the dollar on Thursday even after the dollar rose against other assets. USD/JPY oscillated around the 147.2 level on Thursday. If the USD/JPY pair declines, it may find support near 145.8. If the pair climbs, it may find resistance at 148. 

BOJ Governor Kazuo Ueda hinted earlier in the week that a policy shift may finally be on the horizon. In an interview with the Yomiuri Shimbun newspaper, Ueda admitted the BOJ will be exploring new policy options, if economic and price conditions continue moving upward. Ueda warned that the present ultra-easy policy will continue for some time but indicated that the BOJ is considering policy adjustments further down the track. 

Ueda’s unexpectedly hawkish comments boosted the Yen considerably on Monday. After a short reprieve, however, the Yen resumed its descent. Even though Ueda hinted at a policy shift, a policy change is not imminent and will depend on future economic and inflation data.

The Yen has been weakening, pushed down by the BOJ’s ultra-accommodating monetary policy. The Yen’s weakness has been the subject of concern for Japanese authorities as it undermines the country’s importing potential and causes financial distress in households. 

Japanese authorities have been repeatedly warning speculators against excessive short-selling of the Yen. The Yen’s continued weakness is raising market awareness of another intervention by the Japanese currency to support the ailing currency. Many market analysts view the USD/JPY 150 level as the line in the sand for another intervention.

The BOJ has shown signs of relaxing its ultra-easy policy. The central bank maintained its short-term interest rate target steady at -0.10% at its latest policy meeting in July. The BOJ, however, has loosened its yield curve control. This will maintain the rate ceiling but effectively allow rates to float beyond the cap, allowing for rises by a further 50 basis points. 

National Core CPI dropped to 3.1% in July from 3.3% in June. Inflation in Japan has remained above the BOJ’s 2% target for more than a year, encouraging the BOJ to tighten its monetary policy. BOJ Core CPI dropped slightly to 3.0% in July from 3.1% in June. 

Final GDP data for the second quarter of the year showed that the Japanese economy expanded by 1.2%, disappointing expectations of 1.4% growth. The final GDP Price Index showed a 3.5% annual expansion, versus 3.4% the previous quarter. Japan’s economic recovery increases the odds of a hawkish pivot in BOJ’s monetary policy.

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Written by:
Myrsini Giannouli

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