Euro holds ground against the US Dollar as traders weigh Middle East tensions and Fed outlook

EUR/USD trades on the front foot on Friday but remains on track for a second straight weekly loss as the fragile situation in the Middle East and hawkish Federal Reserve (Fed) outlook keep the US Dollar's (USD) downside limited.

At the time of writing, the pair trades around 1.1400 after climbing to 1.1434 earlier in the American session.

Investors turned cautious after US President Donald Trump said Iran had launched "at least four one-way attack drones" at ships transiting the Strait of Hormuz, calling the incident "a foolish violation of our ceasefire agreement."

Meanwhile, Tehran continues to insist that safe passage through the waterway must be coordinated with Iranian authorities and is pressing ahead with plans to impose transit tolls. Negotiations between the United States and Iran have yet to produce a final agreement after both sides reached a 60-day Memorandum of Understanding (MoU) earlier this month.

The lingering uncertainty is keeping the US Dollar supported after it came under pressure following Thursday's US Personal Consumption Expenditures (PCE) report, which showed underlying inflation remained relatively contained, reducing expectations for a near-term Fed interest rate hike.

The US Dollar Index (DXY), which tracks the Greenback's value against a basket of six major currencies, trades around 101.26 after hitting a more than one-year high near 101.80 earlier this week.

However, traders continue to expect the Fed to maintain a restrictive policy stance in the coming months as inflation remains well above the central bank's 2% target.

Minneapolis Fed President Neel Kashkari said on Friday, "I have one rate hike penciled in for 2026," adding, "I see rates on hold in 2027." Kashkari also said, "I am concerned about inflation, especially in services."

On the Eurozone side, traders are reassessing whether the European Central Bank (ECB) will raise interest rates again as easing energy prices reduce inflation concerns.

However, Commerzbank expects the ECB to deliver one more interest rate hike in September, noting, "In any case, our quantitative model forecasts that, despite lower oil and gas prices, the inflation rate is likely to remain around 3% through the end of the year. This is largely because companies will gradually pass on the higher costs they have incurred so far."