By Peter Nurse

Investing.com - The U.S. dollar weakened in early European trade Monday, while the euro jumped to a three-week high as traders reassessed the European Central Bank’s interest rate trajectory in the wake of last week’s jumbo rate hike.

At 03:05 ET (07:05 GMT), the Dollar Index, which tracks the greenback against a basket of six other currencies, traded 0.8% lower to 107.912, falling back from the 20-year high of 110.79 seen last week.

The European Central Bank raised its key deposit rate to 0.75% from zero last week, its largest ever hike, and President Christine Lagarde guided for another two or three hikes in an attempt to bring inflation at record levels back to the bank’s targeted 2%.

This guidance for further aggressive monetary tightening has pushed the euro higher against the dollar, with EUR/USD up 1.2% to 1.0154, close to its highest level in three weeks.

“Thursday’s step was a clear sign and if the inflation picture stays the same, further clear steps must follow,” Bundesbank President Joachim Nagel said in a radio interview on Sunday.

The ECB officials see a rising risk that they will have to raise their key interest rate to 2% or more, at least another 125 basis points of hiking, to curb record-high inflation in the Eurozone despite a likely recession, Reuters reported Monday.

The single currency has also been boosted by the news of substantial territorial gains made by Ukrainian troops over the weekend, raising the potential, however remote, of an early end to Russia’s invasion of Ukraine.

Elsewhere, GBP/USD rose 0.7% to 1.1667, piggy-backing on the euro’s gains versus the dollar, although the latest economic data showed that Britain's economy grew by less than expected in July when it expanded by 0.2% from June.

Gross domestic product fell by 0.6% in June, which included two days of public bank holidays to celebrate the late Queen Elizabeth's 70 years on the British throne.

However, USD/JPY rose 0.3% to 142.95, heading back towards last week’s 24-year high of just under 145, with the yen remaining rate sensitive.

The Federal Reserve meets next week and is widely expected to hike interest rates by a substantial amount once more.

Fed Governor Christopher Waller said on Friday that he supports "a significant increase at our next meeting," and St. Louis Fed President James Bullard called for another hike of 75 basis points, which would be the third increase of this size in a row.

Risk sensitive AUD/USD rose 0.5% to 0.6872, while USD/CNY traded flat at 6.9265, with the yuan remaining weak as COVID-19 lockdowns continue to threaten a sharp reduction in output at the world’s second-largest economy.