Oil prices hit a 13-week-high, denting optimism that inflation may have peaked.

The Australian dollar was on track to post its first weekly loss in four weeks with a 1.5 per cent decline. It dropped a full cent overnight on Friday to trade at US70.95¢ as investors rushed to the safety of the US dollar. The S&P/ASX 200 index dropped 1 per cent, on track for its worst week since 2020.

Joseph Capurso, head of international economics at CBA, said the local dollar could test US70¢ next week. It fell to US68.29¢ last month, a level last seen mid-2020.

ECB joins the hawkish club

The ECB on Thursday became the latest central bank to join the expanding hawkish club. It ended, as expected, a long-running stimulus program and said it would deliver its first interest rate rise since 2011 next month, followed by a potentially larger move in September.

Central banks have been taking aggressive actions to contain rising inflation by increasing interest rates in outsized increments. The Reserve Bank of Australia was the latest to lift its benchmark rate by 0.5 of a percentage point, following its NZ, Canadian and US counterparts.

The ECB’s hawkish turn sent bond yields sharply higher. Germany’s 10-year government rate – the main proxy for European borrowing rates – surged to its highest level in eight years at 1.47 per cent, before easing to 1.44 per cent. In a more subdued reaction, yields on 10-year US Treasury notes were steady at 3.05 per cent.

In Australia, the three-year government bond, which is sensitive to interest rate expectations, edged up 2 basis points to 3.27 per cent after touching a decade-high 3.29 per cent on Tuesday. Ten-year bond yields jumped to an eight-year peak of 3.66 per cent.

Interbank futures imply a 68 per cent chance of a further 50-basis-point lift in July. They are fully priced in for a 40-basis-point increase.

The ECB warned of inflation challenges and lowered its growth forecast to 2.8 per cent this year. Inflation was revised up to 6.8 per cent this year and 3.5 per cent next year.

“The updated inflation forecasts are too low, and based on an average oil price of $US105.8 for this year and $US93.4 for 2023, they are well below current spot and implied futures prices,” Mr Martin said.

“If current oil prices are sustained, the ECB will likely need to raise rates by 50bps in September and possibly undertake a series of 50bps rises to safeguard its price stability mandate.”

US inflation data to be released later on Friday (Saturday AEST) is expected to show year-over-year inflation of 8.3 per cent, unchanged from April.

The Federal Reserve holds its policy meeting next week and financial markets are fully priced for a 50-basis-point increase, with a chance of a bigger move.

“With energy prices still pushing higher, it is not yet clear that inflation has peaked. Fed guidance and policy actions may have to turn more hawkish for longer,” Mr Martin said.