The euro has faced significant downward pressure against the US dollar this month, falling to its lowest level in over a year. A repricing of market expectations for the European Central Bank's policy trajectory, diverging from the persistently hawkish stance of the Federal Reserve, has jointly driven a period of euro weakness.

Since the start of the month, the euro has depreciated by approximately 2.6% against the US dollar, reaching its lowest point since early June 2025 and significantly deviating from the widely anticipated appreciation path at the beginning of the year. The previously supportive optimistic sentiment has clearly reversed.

The core drivers stem from simultaneous shifts in energy prices and growth expectations. As the US-Iran agreement has pushed oil prices lower, imported inflationary pressures in the Eurozone have eased. Concurrently, weakening economic data has dampened growth expectations, leading markets to rapidly reassess the necessity for further interest rate hikes from the European Central Bank.

At the policy level, the divergence between the US and Europe has become the primary pricing theme. The Federal Reserve's hawkish signals have reinforced the dollar's interest rate advantage, while insufficient growth momentum and receding inflationary pressures in the Eurozone are narrowing the scope for ECB tightening, continuously eroding the euro's appeal.

ECB President Christine Lagarde recently indicated that current economic data does not warrant a stronger policy response, a statement interpreted by markets as a marginal shift in stance. Under the combined influence of falling energy prices, slowing growth, and converging policy expectations, the euro faces continued pressure in the near term.

Lower Oil Prices and Weaker Economy Exert Dual Pressure on ECB

The decline in energy prices is simultaneously constraining the European Central Bank's room for further rate hikes from both the supply-demand and policy expectation perspectives.

On one hand, the significant easing of imported inflation pressure reduces the necessity for continued monetary tightening. On the other hand, months of high energy costs have already substantially dragged on Eurozone economic activity, further weakening growth momentum, creating a dual constraint of "falling inflation + cooling growth."

Lee Hardman, Senior Currency Economist at Mitsubishi UFJ Financial Group (MUFG), noted, "The Eurozone economy has slowed due to the energy price shock. The combination of weakening growth and falling energy prices is alleviating pressure on the ECB to hike rates further."

The latest economic data further reinforces this adjustment direction. The Eurozone PMI released on Tuesday fell back into contraction territory, indicating a broad cooling in business activity. This has undermined confidence in long euro positions, with short-term funds tending to reduce risk exposure.

Pricing in interest rate markets shows traders still fully price in a single 25 basis point rate hike this year, but the probability of a subsequent hike has rapidly fallen from around 50% to approximately 20%, reflecting a clear convergence in policy expectations.

Capital Economics believes this rate-hiking cycle may be nearing its end, potentially stopping after just one more move. The firm points out that Eurozone inflation has likely neared a cyclical peak, with energy inflation set to decline further, limited upside for food and core inflation, and a relatively mild second-round effect from wages. Based on this assessment, Eurozone inflation is expected to gradually return to the 2% policy target over the coming years.