Stronger GDP and hawkish ECB signals fail to halt euro’s retreat

• A recovering Greenback pulls EUR/USD back from its intraday highs.
• Stubborn inflation sustains the Fed’s hawkish stance as concerns over AI spending weigh on investor sentiment.
• The Euro struggles to retain support despite firm Eurozone GDP figures and hawkish ECB remarks.

From an intraday peak of 1.1214, EUR/USD has slipped to around 1.1140 at the time of writing on Friday. The pair has reversed its earlier advance as a rebound in the US Dollar (USD) accompanies increased volatility across financial markets.

A second consecutive day of losses in technology shares initially weighed on the US Dollar on Friday. Investors continued to assess disappointing earnings and question the returns from substantial AI investment. As the sell-off encouraged buying of government bonds, US Treasury yields declined, putting pressure on the Greenback.

After dropping to 101.53, the US Dollar Index (DXY), a measure of the Greenback against a basket of six major currencies, recovered above 102.00. Limiting the US Dollar’s losses, higher energy prices associated with developments in the Middle East continue to heighten inflation risks and sustain the Federal Reserve’s (Fed) hawkish course.

Inflation is still stubbornly above the Fed’s 2% target, according to the latest US PCE figures. Meanwhile, third-quarter GDP growth that exceeded expectations leaves policymakers greater scope to increase interest rates without posing an immediate threat to the economic expansion.

Although the current AI investment boom is adding to inflationary pressures, traders are concerned that slower spending on AI could undermine growth. Speaking on Friday, Richmond Fed President Thomas Barkin said that “the AI investment surge has pressured supply chains, and that is inflationary.” In his view, AI investment is generating demand-led inflation that the Fed can counter.

With these factors in play, a December rate increase remains traders’ favoured outcome; the CME FedWatch Tool assigns it a probability of around 75%. On Wednesday, the US central bank kept rates at 3.75%-4.00% and reiterated its commitment to achieving price stability. Barkin also noted that “the Fed has signaled a gradual approach.”

Eurozone GDP rose 0.4% QoQ in the third quarter, preliminary figures published on Friday showed. This surpassed the 0.2% forecast but marked a slowdown from the preceding quarter’s 0.6%. Growth on an annual basis increased from 1.2% to 1.3%. Neither these encouraging figures nor hawkish remarks from the European Central Bank (ECB) have given the Euro sustained support.

Following Thursday’s ECB decision to keep interest rates on hold, policymaker Fabio Panetta said on Friday that “further increases in policy rates could prove necessary.” With inflation expected to remain above 2% for several quarters, he added that the “outlook for prices is worsening,” and cautioned that the “increase in core inflation could become more pronounced early next year.”