Euro and Dollar: A Tug of War Amid Rate Cut Speculations

The euro hovered near a four-week low against the dollar as the European Central Bank (ECB) is expected to cut interest rates. Traders are focused on the ECB's policy outlook, given slow economic growth and controlled inflation. Meanwhile, the dollar showed gains against the yen, influenced by recent Bank of Japan statements about potential rate hikes.

The euro hovered near a four-week low against the dollar on Thursday ahead of a widely expected interest rate cut from the European Central Bank (ECB), with traders focused on the policy outlook and the extent of further rate cuts. The euro was last seen up 0.06% at $1.1018 but was still close to the prior session's low of $1.1002, marking its weakest level since August 16.

The ECB is almost certain to reduce interest rates by another 25 basis points later on Thursday. Several policymakers have already supported a cut this month, suggesting that their debate will likely center on how rapidly borrowing costs should fall in subsequent meetings amid sluggish economic growth and cooling inflation.

Colin Asher, senior economist at Mizuho Bank, expressed a somewhat pessimistic outlook, mentioning, "Inflation risks have probably shifted more towards the downside, and inflation expectations are under control. This will likely allow the ECB to cut rates not just in September and December, but also in October."

While another rate cut by December is already anticipated by financial markets, the chance of an interim move in October is estimated at about 37%. Overall, traders are pricing in 64 basis points of cuts from the ECB by the end of the year, compared to 103 basis points from the Federal Reserve, which appears set to cut borrowing costs next week for the first time in four years.

Data on Wednesday showed that U.S. consumer prices rose marginally in August, but underlying inflation remained somewhat sticky. As a result, traders reduced their bets on a 50-basis-point rate cut by the Fed on Sept. 18 from 40% a week ago to 13%, according to CMEGroup's Fedwatch tool. "Market pricing for 2024 Fed cuts had been close to its ceiling, making it vulnerable to signs of U.S. data stabilizing," analysts at TD Securities wrote.

In the currency market, the dollar gained against the yen following a turbulent session the previous day. Early Wednesday, Bank of Japan board member Junko Nakagawa reiterated the central bank's tightening stance, and fellow member Naoki Tamura suggested the BOJ must raise rates to at least 1% as soon as the second half of next fiscal year. Tamura added that rate hikes would likely be gradual.

This shift in the Bank of Japan's communication strategy has led to increased volatility in the yen. "The BOJ is trying to get markets to price in a hike using forward guidance instead of media outlets, which is a good change," said Shoki Omori, chief Japan desk strategist at Mizuho Securities. However, he noted that markets are not yet accustomed to this approach, contributing to recent yen volatility.

The dollar was up 0.16% to 142.56 yen at 0846 GMT, after earlier gaining as much as 0.41%. It dipped as low as 140.71 for the first time since Dec. 28, following Nakagawa's remarks. Sterling remained steady at $1.3045, while the Swiss franc was on the back foot with the dollar gaining 0.2% to 0.8543 franc, touching its highest since Aug. 21 at one point on Thursday.

(With inputs from agencies.)