Traders maintained their optimistic stance on the euro, steering it towards a strong recovery as the European Central Bank (ECB) shows a dovish approach after hinting at a possible interest rate cut in September. This optimism in the Euro has overshadowed recent concerns stemming from French political issues.
The euro’s rebound was partly attributed to the European Central Bank signaling increased concerns about volatile inflation, which contributed to the currency’s rise to its highest levels in almost four months. This rise follows a period of instability caused by political unrest within the French government in June.
The European Central Bank’s decision to keep the deposit rate steady at 3.75%, after falling from 4% in June – the first cut in five years – played an important role in the euro’s performance. European Central Bank President Christine Lagarde stressed that the bank is not constrained by a fixed interest rate path, which contradicts Federal Reserve Chairman Jerome Powell’s statement on Monday in which he expressed confidence in moderating inflation in the United States.
The euro has been strengthening this month, gaining more than 2% against the US dollar, showing a marked turnaround from a 1% decline in June. On Thursday, the euro fluctuated around $1.093, but remains on track for its biggest monthly jump since November.
However, the Euro struggled compared to the Swiss Franc and British Pound this month. According to Bill Papadakis, a macro strategist at Lombard Odier, “extreme scenarios related to French political risks are beginning to decline.” Market expectations of imminent interest rate cuts by the Federal Reserve have also contributed to the dollar’s weakness against most other currencies.
Interest rates from the Federal Reserve
The euro has been strengthening this month, gaining more than 2% against the US dollar, showing a marked turnaround from a 1% decline in June. On Thursday, the euro hovered around $1,093, with its biggest monthly jump since November.
Despite this, the Euro struggled against the Swiss Franc and British Pound this month. “Extreme scenarios related to French political risks are starting to ease,” noted Bill Papadakis, macro strategist at Lombard Odier. Market expectations about the possibility of imminent interest rate cuts by the Federal Reserve also contributed to the dollar’s weakness against most other currencies.
Money markets have priced in more than two rate cuts from the Federal Reserve and just under two from the European Central Bank by the end of the year. The dollar, which has been dominant over most rivals over the past year, is now seeing a decline in support as interest rate cuts become more likely. The index, which measures the dollar against major currencies, fell by 2% during July.
The euro’s recovery also reflects easing concerns about the stability of the eurozone, which increased in June when French President Emmanuel Macron’s early parliamentary elections raised doubts about political stability in the region and highlighted France’s large budget deficit. David Zahn, head of European fixed income at Franklin Templeton, expects the ECB to cut interest rates in September and again in the fourth quarter, but expects a gradual pace in the rate-cutting cycle.
European Central Bank President Lagarde on Thursday expressed concerns about economic growth in the euro zone in light of potential global trade tensions. Benjamin Millman, chief information officer at Edmond de Rothschild Asset Management, noted that Trump’s tariff increase poses a major risk to the euro zone’s export-led economy.
How likely is the break-even scenario for EUR/USD?
What will it take to restore parity between the euro and the US dollar? ING believes that further divergence in Fed and ECB policy may be sufficient, but the euro no longer faces the same fundamental pressures that the energy crisis imposed on its fair value in the longer term. It may be necessary to see the two-year EUR/USD swap rate (interest rate differential) widen beyond the low of -175 basis points.
To get EUR/USD closer to the 1.00 parity level, markets will have to cancel all Fed quantitative easing bets for this year while keeping the ECB’s bets between 75 and 100 basis points. Given the extraordinary strength of US data and the ongoing upward revision in Fed interest rate expectations, this is not out of the question.
The base view for analysts and markets remains that the Fed will cut interest rates by one point this year as the US consumer story eventually eases and inflation returns to a more stable downward trend. In line with their call for a 75 basis point interest rate cut in 2024, ING predicts that EUR/USD is more likely to trade in the upper half of the “1.05 – 1.10” range rather than the lower half of the “1.00 – 1.05” range.
Euro Forecast: ECB Has Greater Fears of Currency Decline: The ECB does not appear to be overly concerned about the euro’s decline at the moment. What could cause problems for ECB hawks, at least, are rising oil prices and the possibility of worsening conflicts in the Middle East. With oil prices already more than 10% higher than those in the ECB’s March forecast, at US$90 per barrel, inflation rate estimates could rise by 0.1 to 0.2 percentage points in 2024 and 2025.
