Dollar holds gains on reassuring data, euro slips

By Laura Matthews

NEW YORK (Reuters) - The dollar held gains against the euro on Thursday, pulling the European common currency back from a seven-month peak, after U.S. economic data eased fears of a recession risk and dampened expectations for aggressive interest-rate cuts.

U.S. retail sales rose more than expected in July, a sign that demand is not collapsing and which could prompt financial markets to dial back expectations for a 50-basis-point rate cut next month.

Additionally, fewer Americans than expected filed for unemployment benefits in the latest week, suggesting an orderly labor market slowdown remained in place, although laid-off workers are finding it a bit difficult to land new jobs.

The euro fell 0.36% versus the dollar at $1.0973. It reached $1.10475, its highest level this year, on Wednesday, as markets digested U.S. inflation numbers.

The dollar index rose 0.42% to 103.03, and moved away from the eight-month low of 102.15 touched last week.

"The data this morning goes counter to the recent market narrative of a Fed that is drastically behind the curve and would have to deliver jumbo rate cuts to avert a recession," said Peter Vassallo, FX portfolio manager at BNP Paribas Asset Management. "Market pricing has adjusted accordingly, and short-term U.S. rates have risen significantly on the day."

The pound was up 0.17% at $1.2849, as data showed Britain's economy grew 0.6% in the second quarter, in line with economists' expectations and building on a rapid 0.7% recovery in the first quarter of the year.

The pound also strengthened on the euro, which dipped 0.53% to 85.38 pence.

Thursday's U.S. data follow Wednesday's release of the consumer price index, which rose moderately in July, in line with expectations, and the annual increase in inflation slowed to below 3% for the first time since early 2021.

The figures add to the mild increase in producer prices in July in suggesting that inflation is on a downward trend, although traders now think the Fed will not be as aggressive on rate cuts as they had hoped.

"This morning's data absolutely crushed remaining bets on a half percentage-point move at the Federal Reserve's September meeting," said Karl Schamotta, chief market strategist at Corpay.

"Fear of a 'hard landing' in the U.S. economy has been almost fully unwound," he said, "and Fed officials are seen responding with a more cautious start to the easing cycle."

Markets are now pricing in a 74.5% chance of a 25 bps cut next month and a 25.5% chance of a 50 bps reduction, the CME FedWatch tool showed. Traders were evenly split at the start of the week between the two cut options following last week's sell-off.

The yen was at 149.13 per dollar, inching away from the seven-month high of 141.675 per dollar touched during last week's market mayhem and well beyond the 38-year lows of 161.96 it was rooted to at the start of July.

Bouts of intervention from Tokyo early last month and then a surprise rate hike from the Bank of Japan at the end of July wrong-footed investors who bailed out of popular carry trades, lifting the yen.

"Currency markets are suffering whiplash, with the dollar climbing against its rivals on a re-widening in rate differentials," Schamotta said. "Rumors of the death of the 'U.S. exceptionalism' trade look to have been exaggerated, yet again."

(Reporting by Laura Matthews in New York and Alun John in London; additional reporting by Ankur Banerjee in Singapore; editing by David Evans, Jonathan Oatis and Leslie Adler)