The euro (EUR) dropped to a fresh five-year low against the US dollar on 28 April, testing the key 1.05 psychological level. The prospect of a recession set off by Russia threatening to suspend exports of gas to Europe loomed over the market.
The euro has come under downward pressure since Russia’s invasion of Ukraine on 24 February and the shift to a risk-off environment in response to concerns about the global economy, with growing Chinese Covid-19 lockdowns, along with hawkish US Federal Reserve policy.
What is the outlook for the euro value in this environment? Is there potential for parity if the euro trends lower?
In this article we look at the drivers for the exchange rate and the latest euro expectations from analysts to help inform your forex trading.
Euro forecast 2022: Currency sinks on geopolitical, economic concerns
The Russian-Ukraine conflict pulled the euro lower at a time when the currency had been expected to rise in anticipation of the European Central Bank (ECB) tightening the region’s fiscal policy. While the ECB took steps towards tightening in its March meeting, German allocated spending on energy and defence in response to the war.
The euro traded between 1.08 and 1.12 in March but has fallen below 1.10 and then 1.05 in April.
Russian gas supplier Gazprom announced on 27 April that it has halted supplies to Poland and Bulgaria because they did not pay in rubles (RUB), increasing the threat that Russia could cut off deliveries to other countries more reliant on gas such as Germany. Poland primarily generates its electricity from coal and has gas inventories in storage. But a suspension of supplies to Germany would have an impact on the eurozone’s economic growth as the country would need to ration its gas inventories. That could force the ECB to restrain some of its hawkishness on raising interest rates.
Analysts at Scotiabank wrote in their daily forex report:
Hawkish comments in April from ECB officials had raised expectations that the bank could end net asset purchases in late June or early July ahead of an interest rate hike in July, which was bullish for the euro future prediction.
But the Scotiabank report added:
The euro is coming under pressure at the same time as the dollar is catching a bid on tightening fiscal policy out of the US Federal Reserve.
The Fed raised interest rates by 25 basis points (bps) at its last meeting and is expected to announce a 50bps hike in May. Higher interest rates are bullish for the dollar as investors tend to shift their funds into the US to increase their return on investment.
According to a euro projection by Germany-based Commerzbank:
The report added: “By comparison the risks for interest rates and the economy seem higher in the eurozone at present, and above all are looming more imminently. That is why the euro is struggling against the dollar and why the downside risks dominate in EUR-USD.”
So what does the combination of the geopolitical environment and the fiscal policy backdrop mean for the euro’s performance in the future?
EUR to USD forecast
What is your sentiment on EUR/USD?
The short-term euro outlook is likely to remain weighted towards the downside, with the potential for the European currency to drop to parity with the US dollar.
“We think that building economic pessimism and a clearly disadvantageous monetary policy divergence between the ECB and the Fed places the EUR at a clear risk of testing its early-2017 low of 1.0341 in the coming days or weeks,” Scotiabank’s analysts wrote in their latest euro exchange rate prediction.
“If Russia shuts off energy flows, the bloc’s industrial complex may have to heavily reduce output, flipping the eurozone into recession. The Bundesbank estimated last week that an embargo on Russian energy would lead to a 2% contraction in German GDP in 2022. This would pave the way to a test of parity for the EUR as eurozone financial outflows mount due to a worsening economic outlook, which forces the ECB to put off hikes.
According to EUR analysis by Dutch bank ING, as of 28 April the options market priced in a 35% probability that the EUR/USD pair could hit 1.00 before the end of the year, up from 25% earlier in the week and 15% in recent weeks.
“How this [Russian gas] story plays out and the degree to which the eurozone economy is hit (estimates range in the 1-3% of eurozone GDP on a complete cut-off) will help determine EUR/USD levels. But for the time being, EUR/USD remains fragile and a clean break of 1.0500 opens up the 1.0350 area,” the analysts wrote in their euro rate forecast.
“ECB rate hike expectations for year-end are holding up at around 72bp worth of hikes – but our team thinks that if the more bearish European gas scenarios emerge, the ECB will struggle to take the deposit rate above zero.”
Analysts at Citibank were tactically bearish in their euro analysis against the US dollar, as well as commodity currencies such as the Australian, New Zealand and Canadian dollars, and their EUR to GBP forecast.
“Longer term, the ECB hiking rates back to zero can be supportive for EUR. But given the fragility of the euro area growth backdrop for now, a meaningful recovery in EUR looks unlikely near term.” Their six to 12 month EUR/USD forecast is 1.10, with a euro long-term forecast at 1.12.
Note that analyst forecasts can be wrong. Forecasts shouldn’t be used as a substitute for your own research. Always conduct your own due diligence before investing. And never invest or trade money you cannot afford to lose.
Will the euro go up or down?
The direction of the euro may depend on geopolitical factors such as the war in Ukraine and central bank fiscal policy on interest rates.
Why has the euro rate been dropping?
The euro has been falling against other currencies such as the US dollar as Russia’s invasion of Ukraine has caused concern about the impact on energy supply to Europe, and the potential for sanctions on imports from Russia. At the same time, US fiscal policy on raising interest rates is supportive to the US dollar, while a potential recession in Europe could slow interest rate hikes in the region.
Why is the euro stronger than the dollar?
The euro was intended to rival the US dollar as a global reserve currency. However, various economic and political obstacles in the eurozone have prevented that from happening. Still, the EUR/USD is the world’s most liquid currency pair and it enables traders to gain exposure to the eurozone economy.
What determines the value of the euro?
The value of the euro is driven by economic policy in Europe, trade flows, as well as geopolitical and other major events such as Russia’s invasion of Ukraine and the Covid-19 pandemic.