The euro has edged higher against the US dollar, supported by improved risk sentiment as markets remain hopeful that possible US-Iran talks could ease geopolitical tensions and reduce pressure from elevated energy prices. However, the currency continues to face headwinds from rising political uncertainty in Germany following the CDU’s historic regional election setback, which has raised concerns about Chancellor Merz’s leadership and the government’s ability to advance its fiscal agenda. The relative interest-rate backdrop also remains challenging, with increasingly hawkish Fed commentary reinforcing expectations that US rates may need to rise further to contain persistent inflation. Meanwhile, concerns among ECB officials that higher energy and commodity prices could keep euro-area inflation elevated provide some support for the euro, but for now, the combination of German political risk and a more hawkish Fed is limiting the currency’s upside.

The pound remains under pressure against the US dollar, with the fundamental bias still negative amid widening policy divergence between the Federal Reserve and Bank of England. The Fed’s hawkish stance and signal that another rate increase could follow this year contrast with the BoE’s cautious hold and gradual easing bias, leaving sterling at a relative yield disadvantage. Escalating Middle East tensions have also supported safe-haven demand for the dollar, although falling oil prices and lower US Treasury yields have limited its strength and helped contain the pound’s losses. Attention now turns to the upcoming UK and US flash PMIs for fresh evidence on the relative economic outlook, while Fed commentary and geopolitical developments should remain important drivers of GBPUSD.

The yen has come back under pressure after the Bank of Japan’s rate hike to 1.25%, as the absence of clear guidance pointing to another near-term increase disappointed investors and left Japan’s policy outlook comparatively less hawkish. At the same time, expectations for further Federal Reserve tightening have risen amid persistent US inflation concerns and hawkish Fed commentary, widening the perceived US-Japan rate differential and lifting USDJPY toward 158. However, yen selling has been tempered by growing intervention risk after Japanese authorities reportedly conducted rate checks, signalling that they may be prepared to step into the market if the currency weakens further, particularly as USDJPY approaches the psychologically important 160 level.

The Australian dollar has remained supported by increasingly hawkish RBA expectations, with Governor Michele Bullock stressing that monetary policy must prevent supply shocks from generating persistent second-round inflation effects. Surging energy prices have intensified the upside risks to inflation, leaving markets pricing a very high probability of a 25-basis-point RBA rate hike next week and the possibility of further tightening thereafter. This has helped AUDUSD hold above 0.7100, although gains have been limited by a still-firm US dollar as the Federal Reserve signals that additional rate increases may be needed and markets price a meaningful chance of another Fed hike in October. Overall, the Australian dollar continues to benefit from the RBA’s relatively hawkish outlook, but its near-term direction will depend on whether the central bank delivers the tightening now largely reflected in market pricing.