The euro dipped to approximately 1.1585 against the US dollar during Monday's Asian trading session, pressured by a surge in Federal Reserve rate hike expectations following hotter-than-expected US inflation data. Market participants are now awaiting Wednesday's Fed monetary policy decision, with the probability of a September rate increase jumping to around 86% from 72% prior to the release of US PPI data.

US Inflation Exceeds Expectations, Rate Hike Probability Jumps to 86%

Data from the US Labor Department showed that August CPI rose 0.4% month-over-month and 3.4% year-over-year, both readings matching market consensus. However, the core CPI figure surprised to the upside — excluding volatile food and energy prices, core CPI increased 0.3% month-over-month, above both the previous reading and expectations of 0.2%. According to the CME FedWatch Tool, financial markets now price in an approximately 86% probability of a 25-basis-point rate hike at the Fed's September meeting, up from 72% before the release of US producer price data. One chief investment officer noted, "There's no guarantee the Fed will hike next week, but it's hard to see how the central bank justifies keeping rates unchanged." This sentiment underscores that market expectations for Fed action next week have nearly reached a "locked-in" state.

ECB Hawkish Stance Limits Euro's Downside

The European Central Bank last week raised its deposit facility rate to 2.50% at its September policy meeting, in line with broad market expectations. This marks the ECB's second rate hike this year, following the first increase in June since 2023. Analysts at a leading institution expect further hikes following the bank's hawkish policy decision, which reinforced concerns that inflation could remain elevated for a longer period. Analysts at Bank of Nova Scotia pointed out that the ECB's latest decision delivered an "overall hawkish message," with policymakers releasing "updated projections showing inflation still above target at the end of the forecast horizon." The bank believes that President Lagarde's communication and "subsequent comments from key Governing Council members" "lean toward further near-term hikes and have pushed market pricing toward nearly 40 basis points of additional tightening by year-end." This reinforces market perception that the ECB remains firmly focused on inflation risks, despite the softer euro price action.

Institutional Perspectives

MUFG's latest September FX outlook projects EUR/USD at 1.1500 by the end of Q3 2026, 1.1800 by Q4 2026, 1.2000 by Q1 2027, and 1.2000 by Q2 2027. The report notes that while the dollar broadly weakened in August and the euro benefited from dollar depreciation concerns, markets have now almost fully priced in a September Fed rate hike with an 80% probability of two additional hikes before year-end. MUFG expects only one Fed hike while seeing rising risks of further ECB tightening. European political uncertainties — including German state elections and the 2027 French presidential election — will persist. In the near term, the dollar may remain firm, limiting significant euro upside; over the medium term, as the dollar weakens further and eurozone growth improves, the euro could move toward 1.20.

Deutsche Bank maintains its EUR/USD target of 1.20 for end-September 2026, believing the dollar will continue to soften over the next 12 months with the euro having further appreciation potential in the medium term. The report notes that the dollar fell to yearly lows following the Fed's earlier resumption of its rate-cutting cycle, and while it has stabilized recently, headwinds may intensify again. The euro, meanwhile, is supported by European fiscal spending — increased German infrastructure and defense expenditures are expected to drive more robust eurozone growth, narrowing the growth gap with the US. While the scale of dollar strength outflows may not replicate the same intensity, under normal conditions the euro still has room to appreciate, with targets pointing toward the 1.20 level.

Summary

The euro weakened to approximately 1.1585 against the dollar in Monday's Asian session, with August core CPI rising 0.3% month-over-month above expectations, pushing the September rate hike probability from 72% to roughly 86% and pressuring the euro amid broad dollar strength. However, the ECB's hawkish stance provides partial support — Scotiabank notes that the bank's latest projections show inflation remaining above target at the end of the forecast period, with markets pricing in nearly 40 basis points of additional tightening by year-end. The euro faces a two-way tug-of-war between "rising Fed rate hike expectations" and "ECB hawkish positioning as a floor." If the Fed confirms a rate hike on Wednesday and signals further tightening, the euro could extend its decline toward 1.1550; if the Fed holds steady or adopts a dovish tone, the euro may test levels above 1.1650 once again.

(EUR/USD daily chart, source: Yihuitong)

As of 09:57 Beijing time, EUR/USD was trading at 1.1584/85.