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EUR/USD. The Dollar Strengthens Amid Slowing U.S. Inflation. What is Driving the Greenback's Optimism?

The dollar reacted positively to the release of the Consumer Price Index despite its slowdown in U.S. inflation. On one hand, this reaction from the U.S. currency seems unusual, as the Federal Reserve is now almost certain to lower interest rates at its September meeting. However, on the other hand, the greenback's growth is justified, as the latest figures suggest that the Fed is unlikely to adopt an aggressive pace of monetary easing. This fact allowed dollar bulls to make their presence known across the market, including in the EUR/USD pair, where the dollar is approaching the lower boundary of the 1.10 level.

By the numbers

According to the data, the overall CPI increased by 0.2% in August m/m, the same as in the previous month. In annual terms, the index rose to 2.5%, the slowest growth rate since February 2021. The core CPI, which excludes food and energy prices, increased by 0.3% m/m (beating the 0.2% forecast, making it the only component of the report to exceed expectations). In annual terms, the core CPI rose by 3.2% in August, the same rate as in July.

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The report's structure shows that energy prices in the U.S. fell by 4.0% y/y in August (in particular, gasoline fell by 10.3%). In July, this component had risen by 1.1%. Clothing prices increased by 0.3% (compared to 0.2% growth in the previous month). The pace of food price growth slowed to 2.1% (from 2.2% in July). Transportation services rose by 7.9% (compared to 8.8% in July). New car prices fell by 1.2% in August (-1% in July), and used cars dropped by 10.4% (-10.9% in the previous month).

Market Reaction

As mentioned earlier, traders interpreted this report in favor of the dollar despite the overall slowdown in inflation in August. For one simple reason: the market is confident that the Fed will lower the rate by 25 basis points next week, not by 50. The probability of a 25-point scenario is now estimated at 82%, while the chances of a 50-point cut have dropped to 18%.

The August Nonfarm Payrolls report last week tipped the scale in favor of a "moderately dovish " scenario. It became clear that the U.S. labor market is cooling, but not at the pace indicated in July. Therefore, there is no need to put out the fire with a 50-point rate cut.

And yet, certain doubts remained—if the CPI growth report had fallen significantly below expectations, the question of a 50-point cut would have resurfaced. As of today, it can be confidently said that the outcome of the September meeting is almost predetermined. However, there remains intrigue regarding the future pace (and scale) of monetary policy easing, but this question has now moved to the background.

Conclusions

So, the dollar has risen—does this mean it's time to sell EUR/USD? In my opinion, no. The dollar received situational support, and traders confirmed what they've long suspected, but this isn't enough for a sustained downward movement in EUR/USD.

Let's start with the fact that on Thursday (September 12), another significant macroeconomic indicator will be released—the Producer Price Index. According to preliminary forecasts, the overall PPI is expected to reach 2.0% y/y in August. The indicator consistently accelerated for five months (from February to June), but the growth rate slowed to 2.2% y/y in July. Most experts believe this trend will continue in August. The core PPI is following a similar path. After three months of growth (from April to June), it unexpectedly slowed in July to 2.4%. A further decline is expected in August—this time to 2.3%.

In addition, the European Central Bank will hold a meeting on Thursday. This, as they say, is a "challenging task." The market is almost certain that the central bank will lower interest rates by 25 basis points as a result of this meeting. However, at the same time, the ECB may take a very cautious stance regarding further policy easing. Experts believe the ECB will take the next step to reduce rates at the December meeting—provided that inflation in the Eurozone does not start accelerating. If Lagarde's rhetoric is cautious, EUR/USD buyers could regain at least part of their lost ground, pushing the pair back to the middle line of the Bollinger Bands indicator on the daily chart, i.e., around the 1.1090 level. If the ECB casts doubt on the necessity of further monetary policy easing this year (which is unlikely), EUR/USD could return to the 1.11 level.

Given the high degree of uncertainty, it's best to stay out of the market for now. The ECB's verdict could reshape the pair's fundamental outlook.

The material has been provided by InstaForex Company - www.instaforex.com

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