During Friday's Asian trading session (July 24), the Euro edged slightly higher against the US Dollar, trading around 1.1380. This move was supported by the hawkish signals delivered by the European Central Bank (ECB) at its Thursday meeting. The ECB held interest rates steady as expected but clearly left the door open for a rate hike in September, as surging energy prices threaten to keep inflation well above the 2% target.
ECB President Christine Lagarde stated in her press conference that the central bank expects inflation to remain "well above target" until the first half of 2027. She also highlighted that policymakers are on high alert for "second-round inflation shocks" stemming from the conflict between the US and Iran.
Market Puts 95% Probability on a September ECB Rate Hike
The ECB's Thursday rate decision was a classic case of a "hawkish hold." Policymakers kept all three key interest rates unchanged as expected—the deposit facility rate at 2.25%, the main refinancing rate at 2.40%, and the marginal lending facility at 2.65%. However, both the wording of the policy statement and Lagarde's press conference conveyed a clear hawkish message.
In her press conference, Lagarde stated the central bank expects inflation to remain "well above target" until the first half of 2027. This timeframe is longer than what markets had previously anticipated, suggesting the ECB believes the impact of the energy shock on inflation will be more persistent than earlier assessments. She also emphasized that officials are on high alert for "second-round inflation shocks" from the US-Iran conflict—the risk that higher energy prices could feed into core inflation through wage negotiations and corporate pricing behavior.
The market's response was swift and decisive. Data from a well-known financial institution shows that traders currently price in approximately a 95% probability of a 25-basis-point rate hike in September, with a similarly high likelihood of another rate hike in December. This indicates the market has nearly fully priced in the September hike and also holds relatively high expectations for a third rate increase within the year.
Analysts at MUFG observed that, against the backdrop of rising energy prices, "market participants have been increasingly pricing in more hawkish expectations for major central banks, including the ECB and the Federal Reserve, pushing short-term yields to new year-to-date highs." They specifically noted that "short-term yields in Europe have risen more than those in the US recently, causing the yield spread to move against the US Dollar." This explains why the Euro received support following Thursday's ECB decision.
Which Central Bank is More Hawkish: The ECB or the Fed?
MUFG's analysis provides a key perspective for understanding the Euro's recent price action: the short-term yield spread is turning against the US Dollar.
Specifically:
The Eurozone rate market currently prices in 2 to 3 ECB rate hikes over the next year.
The US rate market prices in approximately 2 Fed rate hikes over the same period.
Short-term yields in Europe have risen more than in the US recently, narrowing the spread between US and European bonds.
This shift in the yield spread means that even though the Fed is still raising rates, the pace at which ECB rate hike expectations are rising has surpassed the Fed. This narrowing of the spread between US and European bonds weakens the Dollar's interest rate advantage over the Euro. This is the core logic behind the Euro finding support around 1.1380.
However, whether this yield spread logic is sustainable depends on two key variables: first, whether the situation in the Middle East will further drive up oil prices and force the Fed to accelerate its tightening pace; second, whether Eurozone economic data can support the ECB's hawkish outlook—with Friday's release of Eurozone PMI data being a crucial test for this judgment.
Middle East Conflict Continues to Escalate
Running parallel to the ECB's hawkish signals is the continuous escalation of the Middle East conflict, which is the primary external headwind capping the Euro's upside.
The US Central Command has confirmed launching airstrikes on targets inside Iran for the 13th consecutive night, hitting drone facilities and coastal surveillance sites.
On Thursday, President Trump stated that the US would hold Iran responsible for the Houthi's actions and warned that Iran and its Houthi allies would "soon be hit with major military punishment." This represents another sharp escalation in Trump's rhetoric towards Iran, following his earlier comment that "they haven't suffered enough."
For the Euro, the Middle East conflict exerts downward pressure through several channels:
Safe-Haven Channel: With two major energy chokepoints—the Strait of Hormuz and the Red Sea—simultaneously under threat, global capital continues to flow into Dollar-denominated assets. The Euro, as a risk-sensitive currency, faces systemic selling pressure. Trump's vow of "major military punishment" suggests the conflict lacks a political basis for de-escalation in the near term, meaning safe-haven Dollar buying will persist.
Inflation Channel: With Brent crude oil breaking through $100 per barrel, global inflation expectations are rising. While this logic also supports the ECB's hawkish stance (positive for the Euro), it also strengthens the case for the Fed to maintain high interest rates (positive for the Dollar). The market currently appears to oscillate between these two effects, with the dominant channel depending on market judgment of "which central bank will be more hawkish."
Data Verification: The release of preliminary July PMI data for the Eurozone, Germany, and the US later on Friday will be key data points for testing this tug-of-war. Stronger-than-expected Eurozone PMI data would reinforce the ECB's hawkish narrative and could push the Euro above 1.1400. Conversely, weak data could cause "economic growth concerns" to outweigh "rate hike expectations," putting downward pressure on the Euro.
Institutional Views
Citi stated in early July that global growth resilience and the AI cycle support risk appetite, but US fundamentals limit a sharp Dollar decline. A Fed easing path and a moderate Eurozone recovery create a balance.
At the current July exchange rate near 1.14, the Dollar Index is in a slow downtrend, but European political and fiscal risks cap Euro gains. Supply-side disruptions and geopolitical events add uncertainty. In the medium to long term, the Euro is expected to trade in a range against the Dollar with limited upside. JP Morgan Global Research holds a bearish view on the Euro against the Dollar, emphasizing continued Dollar strength.
The bank believes the Fed's hawkish bias and US economic resilience will continue to support the greenback. A stable labor market, AI-driven growth, and inflation dynamics provide organic support for the Dollar. The Fed's potential rate hike path further widens the interest rate advantage.
JP Morgan states that the Euro faces multiple pressures, including widening growth divergences within the EU, deteriorating terms of trade, and political uncertainty. The bank forecasts the Euro is unlikely to break 1.15 against the Dollar in the short term, with a medium-term target still biased towards the 1.13-1.15 range.
Summary: Euro Seeks Direction Between "Hawkish Floor" and "Geopolitical Headwinds"
The Euro is currently in a classic policy-and-geopolitics-driven dynamic. The ECB's "hawkish hold" on Thursday, particularly Lagarde's warning that inflation would remain "well above target" until 2027, provided clear interest rate support for the Euro. The market's pricing of a 95% probability for a September hike, combined with short-term European yields rising more than US yields, creates a floor for the Euro.
However, the ongoing escalation of the Middle East conflict (13 consecutive nights of airstrikes and Trump's threat of "major military punishment") continues to boost safe-haven demand for the Dollar, limiting the Euro's upside.
The Euro's short-term direction depends on the marginal changes in two key variables: first, whether Friday's PMI data can confirm the resilience of the Eurozone economy; and second, whether there are any signs of de-escalation or further deterioration in the Middle East situation. Until these factors become clearer, the Euro is likely to consolidate in a range between 1.1350 and 1.1430 against the Dollar.
For traders, the ECB's hawkish signal provides the "confidence" to go long on the Euro, but the Middle East geopolitical risk requires a realistic constraint on upside potential.
At 14:21 Beijing time on July 24, the Euro was quoted at 1.1382/83 against the US Dollar.
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