EUR/USD Annual Price Forecast: Parity looks likely in 2025 as the gap between European economies widens.
- Central banks continue to prioritize inflation, but growth is expected to take the lead.
- The potential return of Donald Trump to the U.S. presidency is likely to have significant global implications.
- Meanwhile, the EUR/USD pair is set to test parity during the first half of 2025.
The EUR/USD pair began the year trading at approximately 1.1040 and ended near its annual low of 1.0332. By September, the pair had surged to 1.1213, and the Euro (EUR) appeared poised for global dominance.
Throughout the first half of the year, the financial world focused on inflation levels and the anticipation that central banks would ease their monetary tightening policies. However, as the year draws to a close, it has become evident that these expectations were not realized.
Expectations that central banks would implement extensive easing measures amid falling inflationary pressures, which were still within their targets, gradually faded. Over time, concerns about employment and growth became more pronounced, eventually overshadowing worries about inflation.
It is important to note that central banks’ primary focus is on inflation and employment, not economic growth—though their policies can influence it. This dynamic played out throughout 2024.
The European Central Bank’s decision was based on questionable grounds
The European Central Bank (ECB) was one of the first central banks to adjust its monetary policy. After a year of tightening measures, the ECB announced its first interest rate cut in June, lowering its three key rates by 25 basis points (bps) each. In December, the ECB implemented its fourth rate cut, bringing the main refinancing rate, the marginal lending facility rate, and the deposit facility rate to 3.15%, 3.4%, and 3%, respectively.
The ECB’s decision to ease monetary policy was driven not by inflation concerns but by fears of an economic slowdown. Initially, officials refrained from publicly acknowledging this, but by the final quarter of the year, they began to do so more explicitly.
Inflationary pressures have notably diminished from the peak levels seen in 2022. The Harmonized Index of Consumer Prices (HICP) fell to 1.7% year-on-year (YoY) in September 2024, a sharp decline from the 10.6% recorded two years earlier. However, HICP increased in the following months, reaching 2.2% in November.
Despite this, economic growth has remained sluggish. Various macroeconomic indicators suggest the risk of a recession is still present. In the third quarter of 2024, seasonally adjusted Gross Domestic Product (GDP) grew by 0.9% in both the euro area and the European Union (EU), driven by an unexpected 0.4% increase in the three months leading up to September. However, these numbers failed to ease concerns about the economy’s progress.
More importantly, the Purchasing Managers Index (PMI), which gauges manufacturing and services activity across the EU, showed that the manufacturing sector continued to contract for a second consecutive year, with only the services sector performing well. The December Composite PMI for the EU stood at 49.5, far below the peak of 60.2 seen in 2021.
Weak consumer spending is expected to persist into 2025, likely prompting the ECB to maintain its loose monetary policy, even if inflation remains above its target.
The ECB’s policies have not been the only factors influencing European growth; political instability has also added to the challenges. In Germany, the coalition government collapsed after Chancellor Olaf Scholz was ousted by a no-confidence vote in the Bundestag, leading to a snap election in February. In France, the entire cabinet resigned following a no-confidence motion passed by the National Assembly against Prime Minister Michel Barnier’s government.
The rise of extremist political parties has become an additional concern, with far-right factions opposing European Union integration and left-wing groups pushing for increased public support.
Has the US Dollar’s rally come to an end, or is it just getting started?
Across the Atlantic, developments unfolded differently, but the US Dollar (USD) remains the standout performer of the year. The Dollar Index (DXY) reached its peak on December 20, hitting its highest level in over two years at 108.55, marking a sharp rise for the third consecutive month.
While President-elect Donald Trump played a central role, he was not the sole driver. The USD’s impressive rally began in late September, fueled by market concerns about the potential implications of the US presidential election. Investors feared that a Trump victory could lead to a significant shift in foreign and fiscal policies.
Trump not only won the presidency but also saw the Republican Party take control of both the Senate and the House. This unified control of the executive and legislative branches strengthened the president-elect’s influence going forward.
What is causing concern in the markets regarding Trump’s policies?
In general, a Republican victory is typically seen as favorable for financial markets. Wall Street surged, with all three major indexes reaching record highs, spurred by Trump’s promise to cut taxes and impose tariffs on foreign goods and services. The US Dollar generally strengthens along with domestic equities, while government bonds tend to weaken.
The optimism, however, is tempered by the growing risks of inflation driven by Trump’s policies. Low unemployment, or more accurately, high employment levels, could signal increased consumer demand, potentially leading to higher prices.
Typically, moderate price pressures under a Republican administration are not a major concern, but timing is crucial. Trump will assume office shortly after the Federal Reserve (Fed) initiated an easing monetary policy, following a tightening cycle that raised interest rates to multi-decade highs to combat inflation.
Investors have already felt the strain of rising inflation. The potential implementation of tariffs could result in higher prices for a broad range of goods and services for Americans. Additionally, Trump’s tariff policy could have ripple effects on other major economies, with European policymakers expressing concerns over its potential negative impact on local inflation.
What is the current stance of the Fed?
The US Federal Reserve (Fed) reduced interest rates three times in 2024, implementing a 50-basis point (bps) cut in September, followed by 25 bps reductions in both November and December, bringing the target range to 4.25%-4.50%.
Throughout most of 2024, Fed officials prioritized inflation, with only a temporary shift in focus towards employment. While concerns about growth existed, they were less pronounced compared to Europe.
Inflation took center stage again in the Fed’s final meeting of the year. Policymakers described the decision to lower the benchmark interest rate as a “close call” and hinted at a more gradual pace of rate cuts in 2025, as inflation remains above the Fed’s target and economic growth remains relatively strong.
According to the Summary of Economic Projections (SEP) or dot plot, officials indicated that they are likely to reduce rates only twice in 2025, representing a significant reduction from the committee’s earlier expectations outlined in the September SEP.
EUR/USD in 2025: Economic Divergence Between the US and Eurozone Expected to Grow
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