The euro experienced a significant drop of 0.9% against the US dollar on Thursday, sliding to the mid-1.02 level, a point not seen since November 21, 2022. This decline at the start of the new year highlights the ongoing weakness of the common currency against its US counterpart. Concerns surrounding the economic prospects of the Eurozone, coupled with political uncertainties and a widening gap in monetary policy between the European Central Bank (ECB) and the Federal Reserve (Fed), are key factors driving this downward trend in the EUR/USD exchange rate.
The EUR/USD pair has witnessed a sharp descent from its 2024 high above 1.12 in September, marking a substantial 9% decrease over just three months. This euro weakness has been further amplified by the robust strength of the US dollar, which has been particularly pronounced since November, coinciding with Donald Trump’s presidential victory and its associated market impacts.
Eurozone Economic Headwinds Fuel US Dollar Surge
Adding to the pressure on the euro is the cessation of Russian gas transit to Europe, following the expiration of a crucial five-year contract on Wednesday. This development forces numerous European nations to seek more expensive alternatives for heating during a period of harsh winter conditions. While natural gas futures initially spiked to a two-year peak exceeding $4 per million British thermal units (MMBtu) earlier in the week, they have since slightly retreated to $3.66 MMBtu during Friday’s Asian trading session. However, the underlying energy security concerns remain a significant drag on the euro.
Furthermore, recent economic data underscores the challenges facing the Eurozone economy. S&P Global’s final December manufacturing PMI figures for both France and Germany revealed a continued contraction within the manufacturing sector. France reported its most severe contraction in manufacturing activity since May 2020, while Germany’s manufacturing output slumped to a three-month low. These figures paint a concerning picture of the Eurozone’s industrial engine.
France’s central bank has also revised its economic growth forecast for 2025 downwards to 0.9%, a significant decrease from the previous projection of 1.2%. This revision reflects a growing pessimism about the Eurozone’s near-term economic trajectory and further weakens the euro’s appeal against the dollar.
Political Instability Adds to Euro’s Woes
Beyond economic data, political instability in key Eurozone economies is also weighing on the euro. Both France and Germany are currently experiencing political turbulence, with ruling party coalitions facing challenges amidst the rise of far-right political movements. This political uncertainty adds another layer of risk to the Eurozone’s outlook, making the US dollar a comparatively safer and more attractive investment.
Globally, the Eurozone faces increased risks under a potential Trump presidency. The US president-elect has voiced intentions to impose higher tariffs on imports from major trading partners, including China, Canada, and Mexico. Although specific measures targeting Europe are yet to be announced, European automakers, a vital sector for the Eurozone economy, are particularly susceptible to potential tariff increases, adding further downward pressure on the euro.
Monetary Policy Divergence: Fed’s Hawkish Stance Bolsters US Dollar
The US dollar’s current strength is significantly underpinned by a hawkish shift in the Federal Reserve’s monetary policy, further amplified by market reactions to Trump’s presidency. The dollar index has surged above 109, reaching its highest level since November 2022. This strength is not just about Euro weakness, but also about inherent dollar bullishness.
Initially, the Fed commenced an easing cycle with a substantial 50 basis point rate cut in September. However, robust jobs data and improvements in other key economic indicators prompted the central bank to adopt a considerably more hawkish stance. While the Fed implemented an expected 25 basis point interest rate cut in December, the accompanying signals regarding the future pace of easing in 2025 were decidedly hawkish.
The Fed’s dot plot, a key indicator of future interest rate projections, now suggests a more modest half-percentage point rate cut in 2025, a significant reduction from the full percentage point cut projected in September. This revised outlook indicates a slower pace of monetary easing in the US, supporting the dollar’s strength.
Conversely, the ECB is anticipated to accelerate its rate-cutting cycle in 2025. Having already reduced its policy rate by a full percentage point in 2024, analysts predict another percentage-point cut in the coming year as the Eurozone continues to grapple with persistent economic and political headwinds. This diverging monetary policy outlook, with a hawkish Fed and a dovish ECB, further strengthens the US dollar against the euro.
Euro-Dollar Parity in Sight?
Analysts are increasingly suggesting that the EUR/USD pair could reach parity in 2025. This level, last witnessed in 2022 following Russia’s invasion of Ukraine, reflects the deepening economic and policy divergence between the US and the Eurozone. Factors including ongoing political instability within the Eurozone, a slowdown in the Chinese economy impacting European exports, and the uncertain global trade landscape under a Trump presidency all contribute to a less optimistic economic outlook for the region, further supporting predictions of continued euro weakness against a strong US dollar.
