Euro Under Pressure Amid US Tariffs and German Political Shifts

The euro has recently faced significant pressure, making it the weakest among G10 currencies this week. This decline has been particularly marked against commodity currencies like the Norwegian krone, Australian dollar, and New Zealand dollar, pushing the EUR/USD pair close to a crucial support level around 1.0700. Several macroeconomic factors are weighing on the euro’s performance, including anticipated US tariffs, political instability in Germany, and divergent monetary policies between the European Central Bank (ECB) and the US Federal Reserve.

Currency Strength (EUR in Red)

 Source: Prime Market TerminalUS Tariffs and Economic Outlook

The anticipated policy shift under the Trump administration suggests that new tariffs on EU imports could materialize in the first half of the upcoming year. Economists are concerned that these tariffs may disrupt eurozone trade flows, potentially dragging down GDP growth by approximately 0.4 percentage points. While retaliatory tariffs from the eurozone could apply upward pressure on consumer prices, this may also strain the region’s economic growth trajectory.

Furthermore, the ECB is likely to continue reducing the deposit rate closer to 2.00% to stimulate the European economy. This outlook contrasts with the US Federal Reserve's more cautious approach, where expected rate cuts are projected to slow, especially with inflationary risks linked to Trump’s agenda. The interest rate differential has already widened, with US yields increasing more than those in the eurozone. Consequently, expectations for higher US interest rates and slower ECB cuts add further pressure to the euro, potentially driving the EUR/USD rate closer to the 1.0000 - 1.0500 range.

ECB Rate Forecasted to Cut 25bp on 12/12/2024 

 Source: Prime Market TerminalGermany’s Political Landscape and Economic Implications

Adding to the euro’s challenges, Germany is experiencing heightened political uncertainty following the collapse of its coalition government. The breakdown, triggered by the dismissal of the finance minister, leaves the SPD party aiming to govern temporarily with the Greens until a confidence vote in mid-January. If this motion fails, as expected, a snap election could be called by March 2025, which might bring about a shift in Germany’s political spectrum.

Current polls indicate growing support for the centre-right CDU/CSU alliance, along with populist movements on both the right and left. If the CDU/CSU is unable to secure a majority, coalition negotiations could lead to further political gridlock, complicating Germany’s response to economic challenges. This uncertainty, if prolonged, may affect the euro’s stability, especially with a potential shift in policies that could impact trade, energy, and fiscal support for the German economy.

Energy Prices and Broader Economic Impact

The eurozone could potentially benefit from lower energy prices, which have recently shown a downward trend. If oil prices fall further, it could improve Europe’s trade balance and support consumer spending within the region. However, with uncertainty from impending US tariffs and possible political shifts in Germany, the benefits of lower energy costs might be muted, especially if tariffs stymie growth.

West Texas Oil Prices H4

 Source: Finlogix ChartsOutlook for the Euro

Overall, the euro’s near-term prospects appear challenging, with the combined effect of US tariffs, Germany’s political instability, and diverging monetary policies likely to sustain downward pressure. While a shorter period of political uncertainty in Germany could mitigate some risks, the euro may still test lower thresholds in the EUR/USD range, particularly if US tariffs materialize and Germany’s government struggles to stabilize.

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