Euro Weakens as French Bond Turmoil Reduces ECB Rate Hike Hopes

The euro continues to weaken as turmoil in the French bond market dampens expectations of European Central Bank (ECB) rate hikes. This fiscal risk premium, though currently contained, is directly impacting the euro and indirectly reducing ECB rate hike expectations. The pricing for the March ECB meeting has dropped from 80 basis points on September 24 to 45 basis points now, pushing the EUR/USD two-year swap rate differential to -167 basis points.

The dollar remains supported by higher global bond yields and strong equity performance, which has capped USD gains. The ISM services index eased slightly but stayed in expansion territory, with business activity and new orders softening. Employment and order backlogs, along with higher prices paid, offset the decline, keeping the Fed narrative intact. Markets expect an October hold but anticipate a December hike.

The euro is at the bottom of the G10 scorecard, with EUR/USD testing 1.1160 before recovering slightly. The fiscal risk premium leaves room for further declines, potentially testing 1.110 or even 1.100 if bond market stress worsens. Markets await details from Marine Le Pen on a counter-budget.

The Bank of England speakers will provide clarity on a potential November hike, with Catherine Mann, Megan Greene, and Huw Pill among those speaking. Markets price a 21 basis point hike for November, but the broader Sonia curve is seen as too hawkish. Elevated oil prices may keep downward pressure on repricing, with EUR/GBP likely to retest mid-July lows around 0.846.

In the Czech Republic, September inflation is expected to rise from 1.9% to 2.5% year-on-year, slightly above market expectations. Core inflation is also set to edge up, supporting expectations of a CNB hike in November. The koruna is well-placed to outperform regional peers, with EUR/CZK expected to move lower.