Why is the euro retreating despite stronger GDP and hawkish ECB signals?

• A recovering Greenback pulls EUR/USD back from its intraday peak.
• Investors remain uneasy over AI expenditure as sticky inflation sustains the Fed’s hawkish stance.
• The Euro finds no durable support despite firm Eurozone GDP figures and hawkish ECB remarks.

Earlier gains in EUR/USD have given way to losses on Friday, with a rebound in the US Dollar (USD) accompanying increased volatility in financial markets. Having touched an intraday peak of 1.1214, the pair is trading near 1.1140 at the time of writing.

Selling pressure had weighed on the US Dollar earlier on Friday, when technology stocks extended their decline into a second day. Investors continued to assess disappointing earnings and question the returns from substantial AI investment. As the equity sell-off lifted demand for government bonds, US Treasury yields declined, dragging the Greenback lower.

After sliding to 101.53, the US Dollar Index (DXY) recovered to above 102.00. The index measures the Greenback against a basket of six major currencies. Limiting the US Dollar’s losses, higher energy prices associated with developments in the Middle East continue to fuel inflation risks and sustain the Federal Reserve’s (Fed) hawkish stance.

With the latest US PCE figures showing inflation still persistently above the Fed’s 2% target, policymakers have further scope to increase interest rates: stronger-than-expected GDP growth in the third quarter allows them to do so without putting the expansion at immediate risk.

Traders nevertheless worry that reduced AI spending could undermine growth, even while the ongoing investment boom intensifies inflationary pressures. Speaking on Friday, Richmond Fed President Thomas Barkin said that “the AI investment surge has pressured supply chains, and that is inflationary.” In his view, AI investment is generating demand-driven inflation that the Fed can counter.

A December rate increase remains the favoured outcome among traders in this environment, with the CME FedWatch Tool assigning it a probability of around 75%. On Wednesday, the US central bank kept rates at 3.75%-4.00% and reiterated its commitment to achieving price stability. Barkin also remarked that “the Fed has signaled a gradual approach.”

The Euro has struggled to retain support from encouraging growth figures and hawkish remarks from the European Central Bank (ECB). Friday’s preliminary data put Eurozone economic growth at 0.4% QoQ for the third quarter, above the expected 0.2% but below the previous quarter’s 0.6%. On an annual basis, growth increased from 1.2% to 1.3%.

Following the ECB’s decision on Thursday to keep interest rates steady, policymaker Fabio Panetta said on Friday that “further increases in policy rates could prove necessary.” With inflation expected to remain above 2% for several quarters, he said the “outlook for prices is worsening,” and cautioned that the “increase in core inflation could become more pronounced early next year.”