EUR/USD edges lower on Monday, reversing earlier gains as markets swing between risk-on and risk-off sentiment. At the time of writing, the pair trades around 1.1408, easing from an intraday high of 1.1449.
Middle East headlines shape price action at the start of the week in the absence of major economic data releases. The Euro (EUR) climbed earlier in the day as the US Dollar (USD) weakened after Reuters reported that mediators had proposed a 10-day pause in strikes to help revive the interim US-Iran deal. Officials from both countries also signaled that they remained open to diplomacy.
However, sentiment turned cautious again after a separate Reuters report said Yemen’s Iran-aligned Houthis had declared an immediate naval blockade against Saudi Arabia. Markets quickly rotated back toward the US Dollar, wiping out EUR/USD’s earlier gains.
The US Dollar Index (DXY), which tracks the Greenback’s value against a basket of six major currencies, trades around 101.00, recovering from an intraday low of 100.65.
Oil prices have rebounded to their highest level in more than a month since fighting between the US and Iran resumed earlier in July, keeping energy-driven inflation risks in focus and raising the possibility that price pressure could pick up again after cooling in both the Eurozone and the US in June.
Against this backdrop, markets expect both the European Central Bank (ECB) and the Federal Reserve (Fed) to maintain a tight policy stance. The ECB is widely expected to leave its Deposit Facility Rate unchanged at 2.25% on Thursday, although markets are fully pricing in a rate hike by September. Meanwhile, the CME FedWatch Tool shows that the probability of a Fed rate hike in September stands at around 63%.
“Tighter monetary policy when the Eurozone economy is still operating below potential is more likely to limit EUR downside than push the currency higher because it raises the likelihood of a downward adjustment to ECB rate expectations,” Brown Brothers Harriman (BBH) analysts said.
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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