USD: Dollar firms on boosted Fed hike bets
Oil surged this week, rising 10% to around $105, its highest level since May. The US-Iran impasse, accompanied by intermittent bouts of violence, continues to stoke inflation fears.
The move triggered a synchronised sell-off across front-end rates markets, with investors repricing a more hawkish policy outlook across the board.
The 10-year Treasury yield climbed almost 20 basis points this week to trade just below the psychologically important 5% level.
The environment certainly felt more risk-off, something that had largely failed to materialise in recent months despite ongoing tensions in the Middle East. The prospect of a Fed hike next week only added to concerns about tighter financial conditions and the potential drag on growth.
Volatility measures picked up, with the VIX reaching its highest level since late July. Meanwhile, risk-sensitive currencies, including those in CEE and the antipodean bloc, weakened. Equity markets also finished in the red.
The US dollar firmed on safe-haven demand. A stronger-than-expected producer price index release also strengthened the case for a rate hike next week, providing additional support. The report tracks price developments further up the supply chain, namely the prices charged by producers to wholesalers.
On a month-over-month basis, headline PPI final demand rose 0.4%, in line with expectations. Core PPI, which strips out food and energy, increased 0.2%, slightly below the consensus forecast of 0.3%. The underlying message remains one of a supply-driven inflation shock, with energy prices doing much of the heavy lifting.
Markets are now pricing roughly a 70% chance of a rate hike next week. The final test comes with today’s August CPI release.
Consensus expects headline inflation to come in at 3.4%, unchanged from July. An upside surprise would reinforce expectations of further policy tightening and help keep the dollar supported.
EUR: ECB hikes, outhawks, and markets take note
The ECB raised rates by 25 basis points yesterday, taking the deposit rate to 2.50%. Markets repriced hawkishly following ECB President Lagarde’s press conference. She described the hike as a “no-brainer”, citing the conflict in the Middle East as an ongoing source of inflation pressure and noting that inflation is set to remain above target. Markets interpreted the message as signalling that further tightening may still be required.
Textbook market correlations would have pointed to euro appreciation. However, the reaction was broadly muted. There was some strength against high-beta currencies, particularly in the CEE region and the antipodeans, though that appeared to be more a risk-off move as oil prices pushed higher.
We have argued for some time that the rates backdrop has become less supportive for the common currency. When rate expectations are being driven higher by conflict-related oil price pressures, any hawkish support tends to be overshadowed by growth concerns, particularly in the eurozone’s case. Much of this reflects the bloc’s dependence on imported energy.
With markets already starting from a relatively hawkish position, the scope for positive rate surprises is also more limited.
From here, pushing rates much higher risks looking increasingly restrictive. For an economy that continues to hold up relatively well despite the conflict, further tightening could ultimately undermine the euro via the credibility channel more than it supports it through wider rate differentials.
Put simply, the euro looks caught between a rock and a hard place. More hikes risk raising concerns about over-tightening, while no further hikes would likely trigger a dovish repricing. Neither outcome looks particularly supportive for the single currency.
GBP: Strong GDP, but bond story is bigger
Sterling is edging higher this morning after UK GDP surprised to the upside, providing a welcome reminder that the domestic economy remains more resilient than many expected. GDP grew 0.4% m/m in July, up from 0.3% in June and comfortably ahead of expectations for no growth. The three-month growth rate also held at 0.4%, while services, production and construction all contributed positively. Taken together, the figures suggest the UK has retained more momentum than feared despite the backdrop of elevated energy prices and ongoing Middle East tensions.
The data has helped lift both GBP/USD and GBP/EUR, although the moves remain modest. Sterling is still recovering from yesterday’s setbacks, when a hawkish ECB hike pushed GBP/EUR back towards 1.16, while stronger US producer price data briefly dragged GBP/USD below 1.35 as markets increased expectations for further Fed tightening.
More broadly, however, the dominant story remains external. The UK may have delivered the strongest growth performance in the G7 through the first half of 2026, but markets remain preoccupied with the ongoing sell-off in global bond markets. UK borrowing costs have surged alongside peers, with long-dated gilt yields hovering around levels last seen almost several decades ago.
For sterling, that creates a tension. Stronger growth helps justify the market’s relatively hawkish Bank of England expectations and offers near-term support to the pound. However, if elevated borrowing costs continue to erode fiscal headroom ahead of October’s Autumn Budget, the bond market story could eventually spill over into a currency story.
For now, sterling is taking comfort from resilient growth. The bigger test remains whether the UK can sustain that resilience while borrowing costs continue to climb.
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Calendar: September 07-11
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*The FX rates published are provided by Convera’s Market Insights team for research purposes only. The rates have a unique source and may not align to any live exchange rates quoted on other sites. They are not an indication of actual buy/sell rates, or a financial offer.
