European currency markets shrug off U.S. inflation report

3 minutes

The European dollar index lowered on Friday and large currency pairs were kept in recent ranges as markets shrugged off Thursday's high U.S. inflation reading, believing the Federal Reserve's position that it is likely to be a temporary blip.

In May, US consumer prices rose 5% year on year - the largest jump since 13 years ago. The currency markets had been sluggish all week in anticipation of the data, but when it appeared above expectations, there was little market reaction.

The Fed has said repeatedly that it expects any increase in inflation to be monetary and that it is too soon to be discussing reducing its temporary stimulus.

The dollar index edged lower in the Asian session and was reduced on the day at 89.995 at 0723 GMT by 0.1%. It stood on track for a small weekly loss of around 0.2%.

Benchmark 10-year US Treasurys actually rose to a three-month high in the wake of the CPI, as short sellers turned to rising yields.

We agree with the Fed that elevated inflation pressures will prove short-lived, said UBS strategists in a note to clients.

Both the policymakers at the European Central Bank and the Federal Reserve were unusually consistent in stressing that policy will only need to be weakened if inflation becomes more steady — which they currently consider impossible.

There were signs of slightly increased risk appetite in foreign currency markets; the Australian dollar was up 0.2% at $0.7768 and the New Zealand dollar was down 0.1% at $0.7204.

But the British pound was USD1.41695 constant.

A smaller weekly stance of the ECB in its meeting on Thursday had little effect on the euro, which was flat on the day at $1.2181 and set for a dovish gain of about 0.1%.

The ECB announced that it would continue its emergency bond buys at a significantly higher pace, even as it raised its growth and inflation projections.

The index of dollar implied volatility over a six-month period was at its lowest since early March 2020, almost back to the levels it had been at before the COVID-19 pandemic caused volatility to spike.

This glut of liquidity is driving volatility levels lower across asset classes and driving the search for carry, even at the long end of RR curves, wrote ING strategists in a note. In currency trading, carry refers to gains from holding higher-yielding currencies.

This environment should continue to see the dollar gently offered towards those currencies with good stories and a little carry, ING said.

In Russia, the central bank is expected to raise its rate of 5% by as much as 50 basis points - its third rate increase in a row.

The central bank targets an annual inflation of 4% for consumers. It climbed in late 2020 amid global inflation and as the weaker rouble for the world prices filtered out.

But over the other months, the altcoin has recovered slightly while Ether was set for a weekly drop of 10%. Both have stabilised this month but are still trading significantly below their mid-May highs.

Attention now turns to the Fed meeting next week. The central bank is likely to announce a strategy for reducing its monthly bond purchase programme in August or September, but won't start cutting huge purchases until early next year, according to Reuters poll of economists.

Meanwhile, leaders of the Group of Seven richest economies meet on Friday in the English seaside resort of Carbis Bay.

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