Dollar Slides as Softer US Inflation Dims Fed Rate Hike Expectations

The U.S. dollar weakened on Wednesday after retreating from a two-week high as weaker-than-expected U.S. inflation data reduced expectations that the Federal Reserve will raise interest rates in the near term. While easing price pressures boosted risk sentiment across currency markets, rising oil prices linked to escalating tensions in the Middle East continued to fuel concerns over future inflation.

The dollar slipped 0.1% against the Japanese yen to 162.08. Meanwhile, the euro climbed 0.1% to $1.1433, and the British pound also gained 0.1% to trade at $1.3401. Commodity-linked currencies remained firm, with the New Zealand dollar hovering near a one-month high at $0.5819, while the Australian dollar held steady at $0.6983.

The U.S. Dollar Index, which tracks the greenback against six major currencies, eased to 100.81 after falling 0.35% in the previous session, marking its largest daily decline in nearly two weeks.

Fresh economic data showed U.S. consumer inflation slowed to 3.5% year over year in June, while the headline Consumer Price Index fell 0.4% from the previous month, the first monthly decline since April 2020 as energy prices eased. The softer inflation report pushed U.S. Treasury yields lower, with two-year yields dropping nine basis points from a 16-month high.

According to OCBC FX strategist Sim Moh Siong, the weaker inflation reading gives the Federal Reserve greater flexibility to keep interest rates unchanged for longer. He added that although the bank still expects modest U.S. dollar strength by year-end, near-term gains may remain limited without new market catalysts.

Following the inflation report, traders sharply reduced expectations for a July Fed rate hike, with CME Fed funds futures indicating the probability dropped to just 16%.

However, Federal Reserve Chair Kevin Warsh maintained a cautious stance during testimony before the House Financial Services Committee, stressing that the central bank has “no tolerance” for persistently high inflation. At the same time, renewed U.S. military action against Iran and President Donald Trump's reinstatement of a naval blockade on Iranian ports pushed oil prices to one-month highs, keeping inflation risks firmly on investors' radar.

Markets are now closely watching upcoming U.S. producer price data for additional clues on the Federal Reserve’s next policy move.