Dollar index ticks up ahead of U.S. inflation data release

The U.S. dollar index (DXY) saw a slight increase on Monday, amid a quiet start to the week due to holidays in major Asian markets. Attention is focused on upcoming U.S. inflation figures, which are anticipated to provide insights into the Federal Reserve's timeline for potential interest rate cuts.

At the time of writing, the DXY was up 0.08% at 104.19. The index, which measures the strength of the U.S. currency against six major peers, has gained over 2.8% year-to-date.

The euro saw a minor decline of 0.15% against the greenback, with the EUR/USD pair falling to $1.0768, retreating from a 10-day peak touched in early trading, despite a modest recovery last week from its continuous decline in 2024. The euro zone's fourth-quarter economic growth data, set to be released on Wednesday, could indicate the currency's future direction.

The British pound fell by 0.1% to $1.2632, while the Japanese yen appreciated slightly to 149.01 against the dollar, as the market awaits the U.S. Consumer Price Index (CPI) data for January, expected on Tuesday. The impending announcement has capped moves in most major currencies.

Foreign exchange markets are currently influenced by changing expectations regarding the timing and pace of interest rate cuts by central banks as inflation falls. Recent robust employment data in the U.S. has largely taken off a March rate cut by the Federal Reserve off the table, with a first interest rate cut in May now appearing more probable.

Chief Market Analyst Neil Wilson summed up the markets’ expectations from the Federal Reserve in his morning note on Monday:

“Markets remain focused on when central banks will start to cut rates. That puts a lot of emphasis on Tuesday’s inflation data from the US. In December the CPI outstripped forecasts at 3.4% vs 3.2% anticipated, whilst the stickiness of core inflation remained evident as this came in at 3.9%, down marginally from 4.0% in November.

The data is key to the Fed’s decision on when to cut rates – last week’s services PMI prices index pointed to the resilience of inflation and the problems of the ‘Last Mile’; markets have been dialling back expectations for a March cut and it is possible the Fed could wait even longer”.

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U.S. data may affect timing of monetary policy decisions by European Central Bank

This U.S. data has also led to a delay in the anticipated timing for the first rate cuts by the European Central Bank, despite weaker economic indicators in Europe.

As per Reuters, U.S. core CPI is predicted to show a 0.3% increase month-over-month in January, with an annual rate still high at 3.8%. Bank of Italy Governor Fabio Panetta recently suggested that the ECB is nearing the point where it might reduce rates, though this statement had a muted impact on currency and bond markets.

ING analysts have pointed out that Panetta is known for his dovish stance within the ECB's Governing Council, differing from both the more conservative "hawks" and other members with softer views on inflation and monetary policy. In a note on Monday, ING FX analyst Francesco Pesole wrote:

“The number of comments by European Central Bank (ECB) officials has intensified in the past few days, and so has a divergence in views expressed by different members. Fabio Panetta, the most dovish voice in the Governing Council, endorsed rate cut expectations, saying that the time for monetary easing is “fast approaching”. That unsurprisingly differs from the latest remarks by Isabel Schnabel (a hawk), who warned against cutting too early, but also from more dovish members like Mario Centeno and Pablo Hernandez de Cos, who still seem to prefer caution over dovish guidance”.

He added that the bank expects a rally in the euro to dollar rate by the end of 2024:

“Despite some voiced unhappiness from doves like Panetta, consensus among policymakers appears to be favouring holding rates should at least until April’s European wage statistics. June looks increasingly likely as the starting date for monetary easing, and markets are also buying this view with increasing confidence. We agree with a June cut, but still think markets are overestimating the ECB’s easing cycle by around 40bp by December. Conversely, markets pricing for a 125bp of Fed cuts in 2024 seems too conservative (we expect 150bp). The convergence of US and EZ rates will – in our view – be the bigger driver of a EUR/USD rally by year-end".

GBP forecast: Scotiabank says sterling may be in for a “bumpy ride” this week

In the UK, a slew of economic data, including inflation and GDP figures due this week, is expected to influence expectations around the timing of interest rate cuts by the Bank of England, which is currently perceived to be trailing behind the Fed and ECB.

In a British pound forecast issued on Monday, Scotiabank Chief Currency Strategist Shaun Osborne wrote:

“There is a raft of key data reports due in the coming days which will likely shape the pound’s near-term direction. Employment data are due on Tuesday but CPI (expected to firm a little) Wednesday and GDP (expected to weaken) Thursday will drive GBP sentiment. It may be a bumpy ride for the pound this week.

Short-term charts lean bearish but the pound’s solid move off last week’s low and relatively firm close suggest some resilience on the weekly chart. Short-term resistance is 1.2650. Support is 1.2570/1.2575. Key support is 1.2520”.

Japanese yen to be dollar-driven in the near future, says Barclays

Markets have also been keeping an eye on the interest rate-sensitive Japanese yen, strengthened significantly towards the end of last year as early U.S. rate cuts were anticipated, but has since weakened as the timing of the cuts has been pushed back.

Japanese Finance Minister Shunichi Suzuki confirmed on Friday that the government is closely monitoring currency movements.

In a research note made available to Reuters, Barclays analysts wrote:

"Dollar/yen is likely to be driven mainly by U.S. developments in the near future, but intervention warnings are likely to increase in frequency around the 150 level”.

Japanese authorities intervened last year to support the yen when the JPY to USD rate climbed to nearly 151.94.

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Past performance is not indicative of any future results. This information is provided for informative purposes only and should not be construed to be investment advice.