Dollar Declines as Inflation Data Looms: A Potential Game-Changer for Global Markets

The dollar weakened ahead of key inflation data from the U.S. and euro zone, affecting central banks' monetary policy expectations. Speculations of a U.S. rate cut in December contribute to the decline, amidst mixed economic data. Market reactions and upcoming inflation reports will be crucial in determining future currency movements.

The dollar edged down on Tuesday ahead of key U.S. and euro zone inflation data later this week that could affect expectations for major central banks' monetary policy outlooks. The greenback was also on the verge of its first monthly decline in 2024.

"A backdrop where the Federal Reserve can start cutting rates this year, even in December, is consistent with further dollar weakness," said Athanasios Vamvakidis, global head of forex strategy at BofA. He mentioned some weakness in U.S. economic data and recent stronger-than-expected figures from the euro zone as the main reasons for the dollar slowdown. He also highlighted that the Fed had pushed back against speculation about possible rate hikes, preventing the dollar from appreciating further.

Markets are currently more than fully priced for a U.S. rate cut in December. They also discount an 80% chance of such a move in November and a 60% chance in September. Against a basket of currencies, the dollar was down 0.20% to 104.44, for a 1.84% decline on a monthly basis.

The euro was up 0.25% to $1.0885 despite some dovish comments from European Central Bank (ECB) policymakers on Monday and data showing German business morale stagnated in May. ECB's Francois Villeroy de Galhau confirmed market expectations that, barring major surprises, a first rate cut next week is a done deal. But investors have recently updated their bets on future ECB moves, pricing in less than a cut in every quarter in 2024 and early 2025.

German inflation data due on Wednesday and the wider euro zone's reading on Friday will be watched for clues on how soon easing from the central bank could come. All of that data, however, will be a sideshow to the main focus for markets on Friday when the U.S. core personal consumption expenditures (PCE) price index report - the Federal Reserve's preferred measure of inflation - is released. Expectations are for it to hold steady on a monthly basis.

Analysts tried to assess the impact of an upside surprise in U.S. figures as they see the market well priced for benign data. Derek Halpenny, head of research, global markets EMEA at MUFG Bank said markets might be more sensitive to stronger-than-expected incoming data against the backdrop of the increased debate on the Fed's implied neutral policy stance.

Fed Governor Christopher Waller said last week that a key underlying rate crucial for the monetary policy, the so-called R-Star, may rise after years of declines. R-star is the rate that neither stimulates nor restricts the economy while keeping inflation at the central bank's target. "This increased debate on the (Fed's) implied neutral policy stance could have an increasing impact on lifting market yields if the economy fails to slow," said Halpenny.

The yen languished near 157 per dollar and last stood at 156.80 per dollar. BofA's Vamvakidis said a Fed first rate cut in 2024 would "be consistent also with a strengthening of the yen versus the greenback."

However, if markets should discount a Fed that "starts easing its policy in 2025, the yen could test the 160 level again, and more interventions by Japanese authorities will be likely," he added. The Bank of Japan's (BOJ) three key measurements of underlying inflation all fell below 2% in April for the first time since August 2022, data showed on Tuesday, heightening uncertainty over the timing of its next interest rate hike.

That comes ahead of Friday's Tokyo inflation data, a leading indicator of nationwide figures. BOJ Governor Kazuo Ueda said on Monday the central bank would proceed cautiously with inflation-targeting frameworks.

Sterling and the New Zealand dollar both rose to over two-month highs. They last bought $1.2786 and $0.6162, respectively. The Aussie dollar edged 0.25% higher. Australian monthly consumer price index data is due on Wednesday.

In cryptocurrencies, bitcoin slid 1.5% to $68,571, while ether rose 0.3% to $3,903.05.

(This story has not been edited by Devdiscourse staff and is auto-generated from a syndicated feed.)