The Fed should keep rates on hold on Wednesday, but Chair Kevin Warsh’s opposition to forward guidance may encourage markets to hold dollars as protection against hawkish surprises. The sharp fall in oil prices is supporting EUR/USD, but downside risks remain unless a clear de-escalation path emerges. The Bank of England should remain on hold on Thursday.
USD: Weaker on a fragile pause in conflict
The dollar enters Fed week ahead of Wednesday's decision with better momentum. Last week, EUR/USD finally edged lower from its recent range as markets took the escalation in the Middle East more seriously. However, Brent has fallen back to $92/bbl, likely on the back of news that Iran and Oman are negotiating over the Strait of Hormuz and a second day of a pause in fighting with the US.
As discussed in last week's webinar, it would not take much to push oil back above $100 and even $120. Unless conflict continues to pause and negotiations gain traction, we still see room for the dollar to strengthen in the near term.
A lack of de-escalation over the next 48 hours should also keep pressure on the Federal Reserve to sound hawkish on Wednesday. In our preview, we explain why we expect rates to remain on hold, but also why oil has firmly reclaimed a central role in shaping monetary policy expectations. We also suspect that Chair Kevin Warsh's dislike of forward guidance raises markets' perceptions of meeting-day surprise risks. That could encourage precautionary USD buying ahead of the announcement. Markets currently price 8bp for this meeting and 41bp by year-end.
The key US data release this week is Thursday's second-quarter GDP report. Consensus expects annualised quarter-on-quarter growth of 2.1%, unchanged from 1Q. June core PCE is forecast at a moderate 0.2% month-on-month, although it may already look stale by then.
EUR: Gas remains too high for comfort
EUR/USD has bounced back above 1.140 as oil prices dropped sharply today. Still, that move looks somewhat optimistic given the absence of a clear de-escalation path. Any renewed military strikes could quickly send Brent back to $100/bbl and EUR/USD below 1.1380. Potential precautionary USD buying ahead of the FOMC may also weigh on the pair into Wednesday.
Gas prices are another reason we remain cautious on EUR/USD unless tensions ease quickly. Even after today's decline, TTF is trading at €58/KWh, more than 30% above levels at the start of July and close to the March highs. So while Brent is nowhere near its peaks, gas is. Given its importance in eurozone energy imports, the euro's terms of trade – statistically the most important medium-term driver of EUR valuation – are also hovering near March lows and at levels comparable to 2023.
We see limited support for the euro from domestic developments this week. Germany's Ifo surveys are expected to stabilise today, but Thursday's 2Q GDP print should still show only 0.1% QoQ growth, leaving a wide gap versus the US. On Friday, eurozone CPI is expected to rise above 3.0%, but with core inflation still near 2.5%, we do not think that will trigger aggressive hawkish repricing. Markets price 42bp from the European Central Bank by year-end, but that outlook should remain highly sensitive to ongoing oil volatility.
GBP: BoE on hold this week
In our view, the rebound in EUR/GBP – now 1% above the 15 July low of 0.8455 – still has further to run. We discuss the rationale in detail in this note, and our short-term valuation models still suggest the pair is cheap at these levels.
Thursday's Bank of England meeting is the main event. Rates should remain on hold, but the focus will be on whether support for tighter policy broadens within the MPC. Catherine Mann may join Huw Pill and Megan Greene in voting for a hike, although we still expect a 7-2 vote in favour of unchanged rates. Higher energy prices remain an upside risk to inflation, but we expect the updated projections to show CPI peaking comfortably below 4%.
If inflation is still expected to remain contained, we believe the BoE will leave rates unchanged for the rest of the year. With markets pricing 38bp of tightening by year-end, dovish repricing remains, in our view, the clearest near-term risk for sterling.
CEE: Softer geopolitics to set the tone
The end of the month is typically quieter in the CEE region. This week, Thursday brings key growth releases. We expect Czech 2Q GDP at 0.5% QoQ and 2.1% year-on-year, compared with 0.2% QoQ and 2.2% YoY previously, pointing to stronger sequential growth momentum despite slightly softer annual growth. The same day, we expect Hungary's 2Q GDP to accelerate to 1.2% QoQ and 2.4% YoY from 0.8% QoQ and 1.7% YoY, consistent with stronger activity than indicated by earlier estimates and supporting a more constructive growth outlook.
On Friday, we expect Poland's July inflation at 0.9% MoM and 3.1% YoY, up from -0.5% MoM and 2.5% YoY, marking a notable acceleration in headline inflation, largely reflecting higher fuel prices following the expiry of retail fuel support measures.
The Czech National Bank's blackout period ahead of the August meeting starts on Thursday, so board members may provide further signals in the coming days. Last week, Jan Kubicek said another rate hike remains under consideration, but there is no urgency for now. That points to no change in August, in line with our forecast.
The lack of further escalation in the US-Iran conflict over the weekend, together with signs of peace talks, should support some recovery in CEE rates after aggressive rate hike pricing returned on Thursday. High-beta currencies such as the forint and zloty should benefit from this backdrop. By contrast, the koruna could come under pressure and move back above 24.200 EUR/CZK, given its strong link to rate differentials and the extent of recent rate hike pricing.
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