Dollar drops to two-month low on cooling U.S. inflation

By Harry Robertson and Ankur Banerjee

LONDON/SINGAPORE (Reuters) – The dollar fell to a two-month low on Thursday after data showed U.S. inflation slowed sharply in March, bolstering speculation the Federal Reserve’s rate hiking campaign is either already finished or will be by May.

As the dollar slipped, the euro rose to within a whisker of a one-year high, with traders betting the European Central Bank’s (ECB) fight against inflation still has a way to go.

Figures released on Wednesday showed U.S. consumer price index (CPI) inflation came it at 5% year-on-year in March, down from 6% in February.

Core inflation – which strips out volatile food and energy prices – picked up to 5.6%, from 5.5% the previous month.

The dollar dropped after the data was released and weakened further on Thursday, helping the euro rise to a two-month high of $1.1032 – just off the one-year peak of $1.1034 touched in early February. The euro was last up 0.2% at $1.101.

The dollar index, which measures the greenback against six major peers, fell to 101.2, its lowest since the start of February. It was on track for its fifth straight weekly drop and last stood 0.15% lower at 101.33.

“We have seen a dramatic swing in interest differentials in favour of the euro,” said Ben Laidler, global markets strategist at eToro.

“The combination of falling U.S. inflation and rising recession risks have driven expectations of three Fed interest rate cuts this year compared to further hikes from the still-hawkish ECB.”

GRAPHIC – Dollar index

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WATCH BOND YIELDS

Expectations that interest rates and bond yields will stay high in the euro zone but fall in the U.S. is making the euro look more attractive, analysts said.

Minutes from the Fed’s March meeting, also released on Wednesday, showed several officials considered pausing rate hikes after the failure of Silicon Valley Bank. The Fed ended up hiking by 25 basis points (bps) to a range of 4.75% to 5%.

Yet ECB officials look set to keep raising rates. Sources told Reuters that the consensus is converging on a 25 bps increase in May, although some more “hawkish” rate-setters such as Austria’s Robert Holzmann are pushing for 50 bps. The main interest rate currently stands at 3%.

Euro zone bond yields rose sharply on Wednesday, narrowing the gap between German and U.S. 10-year borrowing costs to its smallest in two years.

The dollar was little changed against Japan’s yen at 133.19, after falling 0.39% in the previous session.

New Bank of Japan Governor Kazuo Ueda on Wednesday indicated he was concerned about tightening monetary policy too early and failing to push inflation sustainably to 2%.

Britain’s pound hit a 10-month high of $1.253. It was last up 0.2% at $1.251, on track for its third straight daily gain.

Data on Thursday showed the British economy stagnated in February as strikes by public sector workers hit output.

Meanwhile, the dollar fell to a 26-month low against the Swiss franc at 0.8898. The franc is traditionally seen as a safe haven at times of stress.

John Hardy, head of FX strategy at Saxo Bank, said he expected the dollar to grind lower from here as inflation cools and the economy slows.

“It encourages dollar weakness, as long as we don’t get a major recession or a major reheating,” Hardy said. “Nothing massive, we’re just looking for an extension of the weakness.”

Pricing in derivatives markets shows traders think there’s a roughly 70% chance the Fed will raise rates by 25 bps again in May, and a 30% chance it does nothing. They expect rates to fall to around 4.375% by the end of the year.

By contrast, traders expect the ECB’s main interest rate to peak at around 3.7% by November.

(Reporting by Harry Robertson and Ankur Banarjee; Editing by David Holmes and Mark Potter)