Dollar Slips as Fed Rate Expectations Remain in Focus


The U.S. dollar retreated in early European trade on Friday, easing from a two-month high. Despite the pullback, the currency remained near its recent peak, supported by strong labor data and optimism that a U.S. debt default can be averted. These factors indicate that the Federal Reserve will maintain its tight monetary policy for a longer period.

At 02:55 ET (06:55 GMT), the Dollar Index, which measures the greenback against a basket of six major currencies, declined by 0.2% to 103.267, slightly below Thursday's two-month high of 103.630.

Throughout the week, the dollar index has seen gains of nearly 1%, driven by positive developments in the ongoing discussions to resolve the debt ceiling impasse in Washington. The constructive talks have raised hopes of reaching a deal and avoiding the detrimental consequences of a debt default.

As attention turns back to the Federal Reserve, speculations arise regarding the central bank's future interest rate decisions. Concerns about the country's banking sector have eased, and recent inflation data has shown resilience. Moreover, Thursday's jobless claims figures indicated a tight labor market, with fewer Americans filing new claims for unemployment benefits than anticipated.

Several Fed officials have expressed worries that U.S. inflation has not cooled sufficiently to warrant a pause in the rate hike cycle in June. Investors are eagerly awaiting a speech by Fed Chair Jerome Powell later on Friday, seeking further insights into the central bank's stance.

Current market indicators, such as Fed fund futures prices, suggest a 33% probability of a 25 basis points rate hike by the Fed next month, compared to a mere 10% chance just a week ago.

The EUR/USD pair rose 0.1% to 1.0781, bouncing back from its seven-week low in the previous session. This recovery followed the release of stronger-than-expected German producer prices for April, increasing expectations of additional interest rate hikes by the European Central Bank.

Germany's producer price index (PPI) rose by 0.3% month-on-month in April, surpassing the projected 0.5% decline. The annual figure also exceeded expectations, climbing 4.1% compared to the forecasted 4.0%.

Luis de Guindos, Vice President of the European Central Bank, expressed particular concern about accelerating inflation in the service industries during a statement on Thursday. Another ECB official, Isabel Schnabel, is scheduled to speak later in the day, and her remarks are expected to echo a hawkish message regarding raising borrowing costs until core inflation shows sustainable declines.

The GBP/USD pair advanced 0.1% to 1.2417, showing a modest rebound after facing headwinds from the recent strength of the U.S. dollar.

Later in the session, Bank of England policymaker Jonathan Haskel is anticipated to speak. His remarks could potentially boost the sterling if he confirms that the rate hike implemented last week was not the final one, citing a tight labor market and persistently high inflation.

The USD/JPY pair fell by 0.4% to 138.11 after data revealed that Japanese consumer inflation in April approached a 40-year peak. This puts pressure on the Bank of Japan to adjust its ultra-loose monetary policy.

Meanwhile, the AUD/USD pair rose by 0.4% to 0.6645, while the USD/CNY pair declined by 0.1% to 7.0295. The yuan had previously reached its lowest level in over five months against the dollar, as the exchange rate remains above the psychologically important level of 7.

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