EUR/USD Grinds Higher as Oil Prices Soar

The EUR/USD exchange rate has been experiencing a slow and grinding gain over the past few weeks, reaching near two-month highs. However, this rally is being challenged by the rising oil prices, which have reached $91.76 per barrel, a level not seen since 2007.

This increase in oil prices is significant because it revives the inflation premium and the dollar's carry simultaneously, making it difficult for the euro to rally on a policy convergence story.

The European Central Bank (ECB) has been pricing in two more interest rate hikes by early 2027, which would compress the policy rate gap between the ECB and the Federal Reserve. This compression is unusual and typically supports a 300-500 pip move in EUR/USD.

The market is currently pricing in a 70-90% probability of a further 25 basis point increase to 2.50% at the September 10 meeting, with President Christine Lagarde stating that the bank anticipates inflation remaining well above target until the first half of 2027.