Euro’s resilience against the dollar tested by energy prices and political risks

The euro’s performance, trading not far from its lowest levels of the year against the dollar, is under the influence of a global energy price shock and rising political risk in Europe. The euro was approaching $1.20 in August, but has fallen about 2% this month, dropping to two-month lows just below $1.14.

While a rise in U.S. interest rates, which has restored the Federal Reserve’s credibility in the fight against inflation, has strengthened the dollar, the euro’s outlook has also been complicated by political developments and the renewed rise in oil prices, which could hurt an economy that has proved more resilient than expected.

Chancellor Friedrich Merz is facing the fallout from the far-right’s success in the recent regional elections in Germany, a shock that could force him to soften his promised reform agenda. Meanwhile, French markets are under pressure due to concerns about high debt and political deadlock ahead of the 2027 presidential elections.

“I am somewhat worried about the euro in such an environment,” said Foley, adding that her forecast of the euro/dollar rate at $1.16 in three months is currently under review.

While analysts and investors say there are reasons for euro supporters not to lose hope, as traders are forecasting at least one more interest rate hike in the eurozone this year and the economy is showing resilience, few deny that the currency’s short-term outlook has been complicated by high energy prices.

The euro rose about 13% against the dollar last year, but the war in Iran has hurt the currency this year. The conflict has disrupted liquefied natural gas shipments through the Strait of Hormuz, pushing gas prices above 80 euros per megawatt/hour this month, the highest level since late 2022.

European gas prices need to fall for the euro to resume its rise, but analysts say this is not expected to happen in the near future.

“If you look at commodity price forecasters, most of them forecast that the gas price in Europe will be in the range of 85 to 100,” said Kaspar Hense, senior portfolio manager at RBC BlueBay Asset Management. “If that were to happen, then the euro could easily fall to $1.12,” Hense added.

Meanwhile, discussions about a possible U.S. ban on diesel oil exports would add pressure on the euro, although analysts said this was not their base scenario.