Dollar Hits 40-Year High Against Yen, Euro Slips After ECB Holds Rates

The dollar hit a new 40-year peak against the yen and strengthened against the euro on Thursday, as the European Central Bank left interest rates unchanged but opened the door to a September increase, while renewed conflict in the Middle East pushed oil prices above $100 a barrel.

The dollar index, which measures the greenback against a basket of currencies, rose 0.32% to 101.47, according to Reuters. The euro fell 0.35% to $1.137. The dollar was on track for its biggest daily percentage gain in a month.

The Japanese yen weakened 0.49% against the greenback to 163.93 per dollar, after touching 163.96 — its softest level since November 1986, Reuters reported. The yen has shown little sign of recovery, with expectations of a measured approach to rate hikes at the Bank of Japan compared with global counterparts.

**ECB Holds, Signals September Move**

The ECB kept its benchmark deposit rate unchanged at 2.25%, as widely expected, after raising rates for the first time in nearly three years in June. The refinancing rate remains at 2.4% and the marginal lending rate at 2.65%.

ECB President Christine Lagarde told a news conference that while the decision to hold was unanimous, some governors had questioned whether to hike. "There were some governors who asked themselves whether we should not consider a hike; in other words, raising the three interest rates," she said, according to multiple sources.

Lagarde warned that renewed Middle East hostilities and the resultant rebound in oil prices pose upside risk to the eurozone inflation outlook. "Renewed disruption of energy supplies could increase energy prices further and for longer than expected," she said, as reported by CNBC. "The longer energy prices stay high, the more likely they are to drive up broader inflation through indirect and second-round effects."

She added that the full effects of the energy shock have yet to play out. "As we stand now today, (the milder scenario) looks quite unlikely, let's face it," she said, according to dailysabah.com.

The ECB said it stands ready to adjust all interest rates to ensure inflation stabilizes toward its 2% medium-term target. Eurozone inflation eased to 2.8% in June from 3.2% in May, but Lagarde said the bank anticipates inflation to remain "well above target" until the first half of 2027.

Economists said her comments point to a September hike. "Lagarde's comments at the press conference clearly point to a September rate hike," ING economist Carsten Brzeski said, as reported by dailysabah.com. "The European Central Bank has again turned more hawkish, suggesting that a September rate hike is almost a done deal."

Ed Hutchings, head of developed market rates at Aviva Investors, told CNBC that traders now expect a 0.25% hike in September. "Inflation expectations remain elevated and if sustained further, even tighter policy may well be needed," Hutchings said.

The key reason the ECB was in no rush to act on Thursday was that long-feared second-round effects of the energy price spike have yet to materialize, Lagarde said, according to dailysabah.com. "We are not seeing a second-round effect," she said, noting that firms surveyed by the bank did not point to such impacts in pricing or pay decisions.

**Oil Prices Surge, Fed Rate Hike Bets Rise**

Oil prices rose for a fifth straight day, with Brent touching $100 a barrel for the first time since May 26. Yemen's Houthis said they struck two Saudi oil tankers, increasing the possibility of a second bottleneck on global oil supplies alongside the near-shuttered Strait of Hormuz, Reuters reported. US crude jumped 5.41% to $91.51 a barrel, and Brent was at $100.42, up 6.75%.

The dollar has been rising as renewed strikes in the US-Iran conflict have caused a reversal in oil prices and fanned inflation fears, buoying expectations the Federal Reserve may hike rates. The US economy is seen as more insulated from energy price shocks compared with Europe and Japan, supporting the dollar.

Markets are currently pricing in a 37.9% chance of a rate hike of at least 25 basis points at the Fed's policy meeting next week, up from 11.8% a week ago, according to CME FedWatch data cited by Reuters. For the September meeting, expectations for a hike have climbed to 83.2%, up from 52.4% a week ago.

**Yen Under Pressure, BOJ in Focus**

The yen's weakness continued despite Japan's two-year government bond yield hitting a 31-year high on Thursday on growing bets that the BOJ would accelerate the pace of interest rate hikes. Markets are pricing in about 25 basis points of hikes from the central bank this year, according to LSEG data.

Japan's finance minister reiterated the government was prepared to take decisive action on foreign exchange as needed, after carrying out yen-buying operations in April and May when the yen weakened beyond the 160 level, Reuters reported.

"Higher oil prices have dashed hopes of 1.5% GDP growth this year," said Kit Juckes, a strategist at Societe Generale, as reported by the Miami Herald, noting the yen has lately been the weakest G-10 currency.

Mallika Sachdeva, head of forex thematics at Deutsche Bank Research, said the ultimate impact would depend on the levers the government chooses to use, according to the Miami Herald. "If the Government Pension Investment Fund (GPIF) is mandated to bring money back into domestic assets, this could be very bullish for the yen," she said. "However, if the BOJ is coopted to support bonds through renewed JGB purchases, this could be very negative."

Asked about persistent rumors that she may leave the ECB early, Lagarde said she was not about to depart, according to dailysabah.com. "You are not going to see the back of me before 2027," the ECB president said. "When there are clouds on the horizon, the captain stays on the ship."