EUR/USD: Interest rate gaps come back into the spotlight – Commerzbank

Dollar Strengthens Amid Middle East Tensions

According to Antje Praefcke of Commerzbank, the US Dollar has gained support as investors seek safety during the ongoing conflict in the Middle East, causing the EUR/USD pair to dip below 1.15. She suggests that, aside from heightened market swings, factors such as interest rate gaps and real interest rates may soon play a larger role in currency movements. Typically, declining real interest rates are seen as unfavorable for a currency.

Impact of Geopolitical Uncertainty and Interest Rates

Praefcke highlights that, while central bank meetings are on the agenda this week, developments in the Middle East remain the primary driver in the foreign exchange market. In periods of uncertainty, the Dollar often serves as the preferred safe-haven asset, which has contributed to the recent drop in EUR/USD below 1.15. She also notes that market volatility remains elevated, partly due to conflicting information from the region, making it challenging for traders to assess the situation.

She further points out that, as the conflict persists and energy costs stay elevated, the significance of interest rate differences and real interest rates for currency values may increase in the coming weeks, alongside ongoing volatility.

Central banks, she observes, are unlikely to make immediate changes to their main policy rates, as they remain focused on the risks to both inflation and economic growth.

If the conflict were to end quickly, policymakers would likely expect energy prices to stabilize and treat the recent surge as a temporary shock. This could prompt a reassessment of interest rate forecasts, some of which may already be ahead of actual developments.

Nonetheless, Praefcke believes that markets will closely monitor expectations for interest rates and the direction of real interest rates. Generally, when real interest rates fall—often due to rising inflation while policy rates stay the same or decrease—it tends to weaken a currency.

(This article was produced with the assistance of artificial intelligence and subsequently reviewed by an editor.)