The US dollar lost ground against the pound and euro after July inflation figures met expectations, lowering the likelihood of a Federal Reserve rate increase in September and shifting currency market dynamics.
The US dollar retreated against major currencies after July's inflation data came in as expected, prompting investors to reassess the likelihood of further interest rate hikes by the Federal Reserve. The annual headline Consumer Price Index (CPI) slowed to 3.4% in July from 3.5% in June, while core inflation, which excludes food and energy, also eased to 2.5%. These figures, combined with recent weaker employment data, have led markets to scale back expectations for a September rate increase, with the probability now estimated at 44%, down from a recent high of 60%.
Currency Pairs React to Inflation Print
The immediate market response saw the dollar weaken broadly, with the euro and pound both gaining ground. The EUR/USD pair climbed to 1.1556, outpacing the rise in GBP/USD, which reached a one-month high at 1.3540. As a result, the pound's advance against the euro was more muted, with GBP/EUR settling near 1.17. This shift reflects how inflation data can ripple through currency pairs, affecting not only the dollar's bilateral rates but also cross rates such as GBP/EUR.
Market participants noted that the softer inflation print, following disappointing US employment figures, has reduced the urgency for the Federal Reserve to tighten policy further in the near term. However, with headline inflation still well above the Fed's 2.0% target, the possibility of another rate hike later in the year remains open. Comments from Federal Reserve officials, including San Francisco Fed President Susan Collins, have reinforced this uncertainty, as she indicated that tighter policy could still be warranted if economic conditions change.
Broader Market Implications and Upcoming Data
The dollar's decline was accompanied by a rally in global equity markets, as investors welcomed the prospect of stable US interest rates. Lower volatility typically supports the pound against both the euro and the dollar, but can act as a headwind for currencies linked to commodities, such as the Australian and New Zealand dollars, as well as emerging market currencies. Meanwhile, Brent crude oil traded near $89 a barrel after a volatile session, influenced by reports of potential US-Iran diplomatic progress, which eased supply concerns.
Energy prices continue to play a role in European currency dynamics. ING analysts have highlighted that ongoing tensions in the Gulf are keeping European natural gas prices elevated, limiting the euro's ability to benefit from improved eurozone economic data. This means that recent GBP/EUR moves may reflect euro weakness rather than sterling strength. Oxford Economics has raised its oil price forecast, expecting Brent to average $85 a barrel for the rest of the year, suggesting that the global economy can absorb higher energy costs for now.
Key Data Points and What to Watch Next
For the pound, the next major event is the preliminary release of UK second-quarter GDP data, due Thursday. Economists expect annual growth of 1.1%, which would reinforce the pound's recent resilience against both the euro and the dollar. This release is seen as a critical test for the pound's outlook, especially after July's pullback held key technical support levels. As discussed in recent coverage of the pound's position ahead of UK GDP data, the outcome will help clarify whether the UK's relative economic outperformance versus the eurozone is continuing.
Looking ahead, the dollar's direction will be shaped by further US inflation and employment data, as well as the upcoming Jackson Hole symposium, before the Federal Reserve's next policy decision in mid-September. Thin August trading conditions may limit the scale of currency moves, but the interplay between inflation, energy prices, and central bank guidance will remain central to exchange rate developments.
Headline US inflation for July was 3.4% year-on-year, down from 3.5% in June, while core inflation eased to 2.5%. The EUR/USD spot rate rose to 1.1556, GBP/USD reached 1.3540, and GBP/EUR settled at 1.17. Market-implied odds of a September Federal Reserve rate hike fell to 44% following the data release, compared to a peak of 60% earlier in the month. Brent crude oil traded between $88 and $90 a barrel, with an average forecast of $85 for the remainder of the year.
Central banks use inflation data as a key input for monetary policy decisions. The Federal Reserve targets a 2.0% inflation rate, aiming to balance price stability with maximum employment. When inflation remains above target, central banks may consider raising interest rates to cool demand and contain price pressures. However, if inflation slows or the labor market weakens, policymakers may pause or delay further tightening to avoid unnecessary economic strain. The timing and scale of rate changes are influenced by a range of factors, including global commodity prices, exchange rates, and financial market conditions, making the outlook for currencies sensitive to each new data release.
