Currency markets started the week with major currencies gaining ground against the US dollar as weak American retail sales added further pressure to expectations for a Federal Reserve rate hike in September. GBP/USD rose to 1.3564, while EUR/USD advanced to 1.1606, with the US Dollar Index trading near the lower end of its 99.40 to 100.00 range. Retail sales fell 0.6% in July compared with expectations for a 0.1% increase. The disappointing reading followed a series of data showing softer inflation and weaker labor market conditions, prompting investors to scale back expectations for further monetary tightening.
Markets are currently pricing in only around 7 basis points of tightening at the September meeting, while expectations for cumulative rate increases through next year have fallen to around 35 basis points. The minutes of the Federal Reserve’s July meeting will therefore be the main event for markets this week, particularly after three members voted in favor of raising interest rates. Details of the discussions inside the committee will be closely watched for clues about whether pressure on the dollar is likely to continue.
Sterling is currently benefiting more from weakness in the US currency than from strength in the British economy. Upcoming employment, wage and inflation figures will be important, especially as money markets are still pricing in around 55 basis points of tightening from the Bank of England. Any weakness in wage growth or inflation could quickly force investors to reduce those expectations, limiting sterling’s gains and potentially allowing EUR/GBP to recover toward the 0.8575 to 0.8585 area.
The euro remains relatively stronger, supported by increasing investment flows into eurozone assets as international investors seek to diversify portfolios away from the heavy concentration in US technology and artificial intelligence stocks. The 1.1585 area remains an important level for EUR/USD, while sustained trading above this zone could open the way for a move toward 1.1650.
In Canada, inflation data provided clear support for the Canadian dollar after the annual inflation rate climbed to 3% compared with forecasts of 2.9%. The move came alongside improving economic activity indicators and higher bond yields. The Canadian dollar reached its strongest level in two weeks, with USD/CAD falling toward the 1.3850 area.
Canada’s 10 year government bond yield has risen by around 17 basis points over the past month, reflecting a more positive view of the domestic economy. However, planned US tariffs of 50% on roughly $20 billion worth of Canadian goods remain an important source of risk. For now, the impact appears concentrated in specific industries rather than posing a direct threat to the broader economic recovery.
The US dollar managed to recover part of its losses but failed to establish a clear upward trend, with interest rate expectations remaining the dominant driver. The Dollar Index fell to 99.29 before recovering to 99.58, highlighting the currency’s sensitivity to changing monetary policy expectations.
Slower inflation, weaker employment figures and soft retail sales have given the Federal Reserve more room to keep rates unchanged, helping lift the probability of a September hold to around 63%. However, the July meeting minutes could offer some support to the dollar if they reveal broader divisions within the committee or growing concern over inflation pressures caused by rising energy prices.
Oil prices have also returned as an important factor in currency markets, with Brent crude moving above $90 a barrel amid continued tensions surrounding the Strait of Hormuz. Higher oil prices are bringing inflation risks back into focus and could make it more difficult for markets to continue pricing a less restrictive monetary policy outlook. Escalating tensions between Washington and Tehran and the absence of clear diplomatic progress are also increasing demand for defensive assets, offering the dollar some support during periods of heightened uncertainty despite pressure from lower rate expectations.
The Japanese yen continued to weaken after economic growth figures came in below market expectations. Japan’s economy expanded at an annualized rate of just 1.1% in the second quarter compared with forecasts of 2%. USD/JPY climbed to 159.49, indicating that the impact of the joint intervention that supported the yen at the end of July is gradually fading.
The broader outlook for currency markets this week still favors continued pressure on the dollar unless the Federal Reserve minutes deliver a more hawkish message than investors currently expect. The euro remains relatively well positioned, while sterling’s gains are more dependent on dollar weakness and upcoming UK economic data. At the same time, oil prices and developments surrounding the Strait of Hormuz could become the most important source of sudden market volatility, particularly if they trigger another rise in inflation expectations or stronger demand for safe haven assets.
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