The US dollar climbed to its highest level in more than a year on Thursday after the Federal Reserve left interest rates unchanged while adopting a more hawkish tone, reinforcing investor expectations that additional rate hikes could be delivered in the coming months. Meanwhile, renewed weakness in the Japanese yen prompted fresh verbal warnings from Japanese officials.

Federal Reserve signals potential tightening

The Federal Reserve kept interest rates unchanged within the 3.50%-3.75% range, while new Chair Kevin Warsh began his tenure with a broad review of the central banks policy framework. Updated projections showed that nearly half of policymakers expect interest rates to rise this year as inflation concerns remain elevated.

Fed funds futures markets are now fully pricing in a rate hike by October, according to LSEG data, while stronger-than-expected US retail sales figures further reinforced hawkish expectations.

The euro fell 0.3% to $1.146, while the British pound dropped 0.54% to $1.322, leaving both currencies at their lowest levels in more than two months.

The US Dollar Index, which measures the greenback against a basket of major currencies including the yen, euro, and pound, rose 0.36% to 100.71, its highest level since May 2025.

The index had already surged 0.85% in the previous session, marking its biggest daily gain in more than three months.

The hawkish update from the Federal Reserve raises the risk of a significant bullish breakout for the US dollar, said Lee Hardman, Senior Currency Analyst at MUFG.

The dollar has been supported by a sharp rise in short-term US interest rate expectations, more than offsetting the negative impact from the announcement of the US-Iran agreement over the weekend, he added.

In energy markets, oil prices fell on Thursday after the United States and Iran signed a temporary agreement aimed at ending the conflict, reopening the Strait of Hormuz, and exempting Iranian oil exports from US sanctions, reducing some safe-haven demand for the dollar.

However, lower oil prices were not enough to halt the dollars advance as markets increasingly priced in further monetary tightening.

Markets are currently assessing whether the Strait of Hormuz can truly be reopened to unrestricted shipping, said Kimi Tong, Global Markets and FX Strategist at Everbright Securities International.

Until that becomes certain, sentiment supporting dollar strength is likely to remain dominant, especially given the Federal Reserves increasingly hawkish stance, she added.

Meanwhile, the Australian dollar, often viewed as a risk-sensitive currency, slipped 0.1%.

Japanese yen

The Japanese yen weakened to 160.90 per dollar, its lowest level since July 2024, erasing the gains recorded after Japanese authorities intervened in the foreign exchange market on April 30.

The renewed decline triggered another response from Japanese officials, who reiterated their readiness to support the currency if necessary.

We are prepared to take appropriate action regarding currency market movements whenever needed, Chief Cabinet Secretary Minoru Kihara told reporters on Thursday when asked about the yens weakness.

Elsewhere, attention is turning to the Bank of England, which is widely expected to leave interest rates unchanged at 3.75% at Thursdays policy meeting while policymakers assess the impact of the temporary truce in the Iran conflict on the inflation outlook.