Dollar Weakens Amid Inflation Reports and Rate Cut Speculations

The dollar weakened against major currencies as the U.S. CPI data showed declining inflation, increasing the likelihood of Federal Reserve interest rate cuts. The euro hit its highest level in nearly eight months. Market expectations for a 50 bps rate cut in September rose, while the kiwi and sterling experienced declines.

The dollar softened against its major peers on Wednesday, aiding the euro to reach an almost eight-month peak, as the U.S. consumer price index indicated subsiding inflation. This reinforced expectations that Federal Reserve interest rate cuts are imminent. U.S. CPI modestly increased in July, with annual inflation slowing to below 3% for the first time since early 2021, strengthening the prospects for a rate cut next month, albeit less aggressive than markets anticipated.

The report, along with the small rise in producer prices in July, suggests a downward trend in inflation, providing the Federal Reserve with the opportunity to focus on the labor market amid growing recession fears. "It mildly reduced expectations for a 50-basis point rate cut in September," commented Amo Sahota, director at Klarity FX, San Francisco. The euro rose by 0.18% against the greenback to $1.1014, marking its strongest level since January 2. Consequently, the dollar index slightly dipped to 102.57.

Traders adjusted their speculation for a rate cut in September before the producer price data emerged, and escalated bets for a 50 basis-point cut to 56% from 53% a day earlier, as per CME Group's FedWatch Tool. Sahota anticipates three 25 bps cuts from the Federal Reserve this year, rather than the previously expected 100 bps by year-end.

STERLING DIPS, KIWI SLIDES Despite the weaker dollar, Sterling slipped by 0.29% to $1.2825 after data revealed a lower-than-expected rise in British consumer price inflation in July. The pound weakened against the euro, which increased by 0.47% to 85.87 pence. Financial markets now see a 44% chance of a quarter-point BoE rate cut in September, up from 36% before the data. The kiwi dropped by 1.28% to 0.5999 following the Reserve Bank of New Zealand's quarter-point cut, its first easing since early 2020.

Japanese Prime Minister Fumio Kishida's decision not to seek reelection in the party's leadership race next month had little impact on markets. The yen last traded at 147.26 against the dollar. "The Fed is cutting rates. That should be dollar negative," stated Vassili Serebriakov, UBS FX strategist. "The currency likely to perform best against the dollar is the yen, as the Bank of Japan is raising rates, narrowing rate differentials."

(With inputs from agencies.)