EBC Markets Briefing | Euro eyes more gains on mounting dollar debasement risks

The ECB is expected to raise its key interest rate again Thursday, but most economists reckon the room for further rises is limited. Governing Council members have lately signalled a complex mix of urgency and caution.

They noted that economy is proving more resilient than anticipated. Recent GDP data and business surveys indicate that monetary tightening has cooled inflation without severely impacting output.

Germany's economy grew faster ​than initially indicated in Q2 and business morale hit its highest level in a year in August — signs of a decisive rebound following years of underperformance.

Meanwhile, growth in the eurozone's manufacturing sector hit its fastest pace in more than four years, driven by the strongest rise in new orders since early 2022 and output expanding at a robust rate.

Commerzbank's senior economist Ralph Solveen attributed the improved readings chiefly to stronger external demand, downplaying the impact of government spending.

Markets price a roughly 25% chance of the ECB deposit rate reaching 3% by March 2027 and an about 60% chance by September, although physical Brent premiums collapsed from $40 to single digit.

The euro (EURUSD) bottomed out in late July as Trump appeared at his wit's end regarding Iran. The Italy-Germany 10-year bond yield spread has narrowed dramatically in 2026, underpinning the currency's strength.

Pricey natural gas

Eurozone inflation rose back above 3% in August on higher energy costs. But underlying price pressures remained ​modest, offering some reassurance that the second-round effects were yet to set off.

Reduced Middle Eastern flows have squeezed LNG importers globally, but Europe is uniquely exposed. The region was already highly vulnerable, with natural gas inventories well below normal seasonal averages.

The price of LNG in north-west Europe has surged to a more than three-year high. This spike comes as the continent braces for severe winter supply shortages triggered by escalating conflict in the Middle East.

Market specialists have spent months warning that European gas inventories are dangerously depleted. Compounding the crisis, near-term gas futures prices have remained largely stagnant.

Iran said a deal with Oman to manage shipping through the strait is on the horizon. Some traders believe that will help get more tankers and other commercial vessels through in the long run.

However, the country has threatened to retaliate against any new US strikes by targeting American oil and gas interests across the Persian Gulf, warning that the region's energy infrastructure is heavily "exposed".

The European Commission initially achieved quick "low-hanging fruit" gas reductions, it is finding that actually cutting total gas consumption is a much slower, more difficult structural challenge.

Dollar debasement

Hedge funds increased their short positions on the US dollar, anticipating further clarity regarding Treasury Secretary Scott Bessent's upcoming fiscal strategy aimed at tackling elevated borrowing costs.

According to a Bloomberg gauge for August, the premium required to protect against a declining dollar over this month compared to a potential rally has reached its highest level since February.

Bond traders were even looking to hedge the risk that the Fed pivots to cutting rates in 2027 as the focus could eventually shift from price pressures to the economy weaknesses.

On the other hand, traders have priced in a roughly 57% chance of a September rate hike in the wake of a rosy nonfarm payrolls report, with much now depending on Friday's inflation data.

While Trump hailed the job figures, he urged Warsh to decrease borrowing costs immediately. Independence of the central bank has been questionable as federal debts continue to swell.

Foreign central banks are pushing ahead with gold accumulation as a buffer against systematic risk. Norges Bank Investment Management, the world's biggest sovereign wealth fund, plans to cut its Treasury holdings.

The failure to suppress Treasury yields has delivered another setback to the greenback. At around 4.8%, the 10-year benchmark has now wiped out all gains from the "Bessent Twist".

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