Hot CPI data pushes USD higher, but what will the ECB rate decision mean for the EUR/USD?

Yesterday’s US inflation data will leave analysts scratching their heads. YoY inflation continued to fall, down to 2.5% vs. 2.6% expected, but monthly core inflation, which strips out volatile energy and food prices, rose 0.3%—the largest increase since April.

Despite the mixed data, markets decided this is enough for the Fed to ditch the idea of a 50bps rate cut next week, with the odds dropping to 13%.

“We wanted answers to help settle the 25bp vs 50bp Fed rate cut debate on Friday, but now it seems the market has made its own mind up,” said Chris Weston, head of research at Pepperstone, referring to last Friday’s NFP report.

“We are now comfortable with calling a 25bp cut for September, but also open-minded to the idea that a weak U.S. payrolls report on 4 October would fully open up a 50bp cut in the November FOMC meeting.”

The EUR/USD fell sharply following the data release, continuing its week-long bear run – though strong resistance at the 1.1000 led to a clawback in overnight trading.

But with the .25% rate cut almost certain, why has USD strength remained? There are three reasons: The first is risk aversion because of the surprise increase in core inflation. Second, traders are waiting for the European Central Bank’s interest rate decision (due later today) before making any big moves. Finally, a range of large options are expiring around the 1.1000 level today. Following the expiry, we should see volatility tick up on a particularly busy day for news releases.

First, the European Central Bank is expected to lower interest rates by 25bps later today. Once the decision is made, the question is how low the EUR/USD can fall. It’s unlikely that the ECB rate cut will give further impetus to the EUR/USD. The eurozone is in danger of falling into recession, and traders are more concerned with the long-term economic outlook.

So, any significant volatility will come from the ECB’s forward guidance, with big question marks over further cuts in October and December. Inflation-wary hawks are still in the majority, with markets only pricing a reduction next month at about 40%.

Later in the day, we will have the US weekly jobless claims data. Considering the importance the Fed places on the labour market, a weak reading could potentially revive the 50bps cut question. It would undoubtedly inject more volatility into the market.

Overall, after a relatively quiet week, we could see the return of some major price movement, not just in the EUR/USD but in other major pairs as well.