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The combined effect of a hawkish ECB and US data (consensus core CPI and spike in jobless claims) has sent the EUR:USD short-term rate differential to the tightest in a year. Spot has only partly followed higher, and we see more upside risks for EUR/USD in the near term. We have published previews for the Fed and Norges Bank meetings next week.
 

USD: Three cuts validated

Yesterday’s US CPI report showed slightly hotter than expected headline inflation (0.4% MoM), while the more closely monitored core rate rose by 0.3% MoM in line with consensus. What matters the most is the limited tariff impact. Price increases were driven by airline fares, used cars, shelter, food, and energy, while recreation and medical care saw declines. Notably, core goods excluding autos rose just 0.1%, suggesting that companies are currently absorbing tariff costs in their profit margins, in line with what PPI trade services data showed earlier this week. It’s far from guaranteed that this profit-squeezing is sustainable, but for now, markets are receiving validation of Fed dovish bets.

And even more validation is coming from job market news. Initial jobless claims unexpectedly spiked from 236k to 263k in the week to 6 September, the highest since October 2021. This could be a signal of increasing layoffs amid an already soft hiring environment.

Here is our preview of next Wednesday’s FOMC meeting. We are aligned with the markets and consensus in expecting a 25bp cut, to be followed by similar reductions in October and December. The data-led dovish repricing has now made three cuts firmly the markets’ base case too (72bp priced in by December).

The dollar’s drop yesterday looked substantial on paper, but our model shows that the greenback is expensive relative to the latest short-term rate swings against most of the G10. We expect dollar weakening as the Fed starts cutting, even if now priced in, as cheaper funding costs can further encourage USD selling for hedging purposes.

Today, we’ll see the University of Michigan surveys, keeping a close eye on inflation expectations, which currently stand at 4.8% for the year-ahead and 3.5% for 5-10 years. The balance of risks for the dollar remains tilted to the downside.
 

EUR: Lagarde doubles down on 'good place'

Yesterday’s ECB meeting proved more eventful than we had anticipated. After an initial dovish reaction to the statement – likely due to a slight downward revision in 2027 inflation forecasts – the euro spiked on the back of President Lagarde’s hawkish remarks. The balance of risks for growth is now seen as “more balanced”, and there was strong wording on the fact that the disinflationary process in the euro area is now over. At the same time, Lagarde steered clear of any headline-catching comments on French bonds, which we thought was a major dovish risk.

All in all, the implicit message to markets was that there are no reasons to keep pricing in additional rate cuts as things stand. Indeed, the implied probability of further easing dropped below 50% after Lagarde’s presser, offering strong rate-driven backing to the euro rally.

While we wouldn’t fully rule out a resurgence of dovish sentiment – especially as tariffs, a strong euro, and geopolitical or sovereign debt risks may prompt future action – our baseline view remains aligned with market expectations: the ECB is done cutting rates.

The combined effect of hawkish ECB and US jobless claims spike sent the EUR:USD 2-year swap spread to -110bp, very close to the late September 2024 levels, when the Fed had just cut 50bp. While the spread is still some 35bp wider compared to the last time EUR/USD was trading at these levels four years ago, the medium-term rate-implied risk premium on the dollar has shrunk substantially, making further EUR/USD gains more feasible. A break above 1.180 in the near term now seems rather likely.
 

GBP: Awaiting key data

The pound has held up well against ECB-led euro strength. And if it’s central bank divergence we are looking at, EUR/GBP is hardly cheap.

Some UK data for July were out this morning. Monthly GDP was in line with consensus (0% MoM, 0.2% 3M/3M), while industrial and manufacturing production dropped unexpectedly.

Nothing in those figures carries significant implications for the Bank of England, though. Next week will be busy with jobs and inflation numbers: our BoE call (November cut) remains more dovish than markets’ and we see upside risks for EUR/GBP. But until those figures are released EUR/GBP may prefer the lower end of the 0.86-0.87 range rather than a break higher.
 

NOK: We narrowly favour a cut next week

We talked yesterday about the krone’s good performance, partly due to some domestic hawkish repricing. The Regional Network Survey didn’t make our call for next week’s Norges Bank meeting any easier, as it showed resilient output and hiring expectations.

However, as per our meeting preview, part of those expectations is based on anticipated rate cuts. Plus, the real interest rate in Norway is elevated and the recent good NOK performance is another incentive to cut now. Markets are pricing in 15bp, and while we admit it’s a close call, we slightly favour a cut next week.

This should pave the way for a short-term EUR/NOK rebound (we target 11.70 near term), although strong NOK fundamentals still argue for a structurally lower EUR/NOK in the coming quarters.

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