Dollar retreat reshapes the FX landscape
Market overview
Currency markets moved decisively as investors reassessed the outlook for global interest rates. The dollar’s decline gathered momentum, prompting a broader rotation across G10 currencies and exposing stretched positioning built around expectations of sustained Federal Reserve tightening. Softer US inflation and growth data reinforced the move, while sharp yen appreciation added to volatility and accelerated the unwinding of dollar longs. Sterling remained comparatively steady following the Bank of England, while the euro benefited from the weaker dollar despite offering limited domestic momentum of its own.
USD: Dollar longs face a deeper squeeze
The post-FOMC dollar sell-off extended as investors questioned whether the Federal Reserve is prepared to turn its inflation warnings into further tightening. Uncertainty surrounding Chair Kevin Warsh’s policy reaction function also weakened confidence in the rate-hike narrative that had supported the dollar through the summer.
US data added to the pressure. Core PCE inflation increased by just 0.1% month-on-month in June, while annualised second-quarter growth of 1.5% fell short of forecasts. Japanese intervention then drove USD/JPY more than 3% lower, intensifying the broader deterioration in dollar sentiment.
The DXY index briefly slipped below 100 and touched its lowest level since 17 June. Positioning likely magnified the fall, with speculative dollar longs recently reaching their most stretched level since January 2025. Further liquidation remains possible, particularly if upcoming US data disappoints or Federal Reserve officials signal less support for tighter policy.
GBP: Bank of England delivers a cautious hold
The Bank of England kept Bank Rate unchanged at 3.75% in a 6-3 decision. Pill, Greene and Mann supported an increase, while Bailey, Lombardelli and Ramsden joined the more dovish members in voting to hold.
Sterling showed little immediate reaction, although short-dated gilt yields fell by as much as 12 basis points. Market expectations for a September rate rise dropped from roughly 60% before the meeting to around 30% afterwards.
The decision balanced persistent inflation risks against continued weakness in the labour market. Updated forecasts presented a slightly softer inflation outlook than in April, but inflation is still projected to peak at 3.2% in the fourth quarter of 2026. The result was a cautious but hawkish hold, with limited appetite to tighten immediately but little indication that policymakers are ready to turn decisively dovish.
EUR: Break above 1.150 opens further upside
EUR/USD moved through 1.150 with little resistance as broad dollar weakness remained the dominant market driver. The euro initially performed strongly following the Fed decision, although it later trailed several G10 currencies despite encouraging regional data.
Eurozone second-quarter GDP expanded by 0.4% quarter-on-quarter, while inflation readings from Germany and Spain exceeded expectations. Attention now turns to eurozone-wide inflation, with headline CPI forecast at 2.9% and core inflation expected at 2.4%.
A September European Central Bank rate rise is already largely reflected in market pricing, which may limit further support from European yields. Even so, the sharp reversal in dollar momentum leaves near-term risks for EUR/USD tilted higher. The 1.150 area may continue to attract buyers, although a sustained move above 1.160 would probably require a more meaningful fall in US rate expectations.
Looking ahead
Eurozone inflation will shape expectations for the ECB’s September meeting.
US data releases will be closely watched for signs of further economic weakness.
Federal Reserve commentary may drive larger market moves following the split FOMC vote.
Positioning remains a key risk, with further dollar-long liquidation still possible.
UK inflation will determine whether expectations of a future Bank of England increase regain momentum.
EUR/USD may remain supported near 1.150, while USD/JPY is likely to stay sensitive to intervention risk.