The euro fell to its lowest point in a month against the U.S. dollar during early European trading on Tuesday, slipping to 1.1362, as markets remained cautious ahead of the Federal Reserve's upcoming monetary policy announcement. The greenback extended its gains amid this cautious sentiment.
Market participants widely expect the Fed to keep interest rates unchanged at its current meeting, holding the target range at 3.50%-3.75%. All attention is now focused on the Fed's monetary policy statement and the subsequent press conference with Chair Walsh for the latest clues on inflation and the economic outlook. It appears unlikely that the Fed will make any definitive remarks regarding the future path of monetary policy.
According to Francesco Pesole, a foreign exchange strategist at ING, the euro remains at risk of further declines despite a recent pullback in oil prices following a temporary halt in hostilities between the U.S. and Iran. Any new military escalation could quickly push Brent crude oil prices back to $100 per barrel, which would likely drive the euro lower against the dollar. Furthermore, underlying demand for the dollar before the Fed's decision is expected to keep pressure on the EUR/USD pair.
High natural gas prices provide another reason for a cautious outlook on the euro, unless geopolitical tensions ease swiftly. In the eurozone, investors are awaiting the preliminary July Harmonized Index of Consumer Prices (HICP) data for Germany and the broader eurozone, scheduled for release on Thursday and Friday, respectively. Market participants are closely watching these inflation figures, as they are expected to significantly influence expectations for the European Central Bank's interest rate trajectory.
Neil Shearing, chief economist at Capital Economics, noted that while markets currently price in just over 50 basis points of rate hikes from the Fed, the Bank of England, and the European Central Bank by mid-2027, policy paths could diverge by next year. Should the conflict in the Middle East end, energy prices would decline, allowing domestic economic fundamentals to become the primary driver of monetary policy. However, underlying inflation pressures remain weaker in the UK and the eurozone. The situation is different in the U.S., where fiscal policy also remains more accommodative. It is becoming increasingly difficult to justify the tightening expectations for the ECB and the Bank of England currently reflected in the market, though the Fed may resume its tightening cycle in the near future.