Key Moments
- EUR/USD trades near 1.1635 in early European dealings on Friday as bullish momentum fades.
- The White House confirms a draft 60-day ceasefire extension MoU between the US and Iran, but President Donald Trump has not yet signed off.
- Markets fully price in two ECB deposit rate hikes, while economists project two hikes followed by a cut in mid-2027, according to a Reuters poll.
Early Europe: EUR/USD Under Pressure
The euro weakens against the US dollar in early European trading on Friday, with EUR/USD easing back toward 1.1635. The pair is retreating as traders respond to conflicting signals around a potential US-Iran peace arrangement and prepare for preliminary German inflation figures due later in the session.
Middle East Developments Drive Risk Sentiment
According to the White House, Washington and Tehran have agreed on a memorandum of understanding covering a 60-day extension of the current ceasefire to facilitate formal negotiations. However, the agreement still requires approval from US President Donald Trump.
US Vice-President JD Vance said on Friday that the US and Iran still need to work out several sticking points before an agreement on the war can be reached. Market participants remain focused on how the situation evolves, given its potential to influence broader risk appetite and currency flows.
Traders are expected to track Middle East headlines closely. Any indication of renewed frictions between the US and Iran could pressure the euro against the dollar. Conversely, tangible progress toward a peace deal could lend support to risk-sensitive assets, including the single currency.
ECB Outlook and Rate Expectations
Comments from European Central Bank officials are another key factor for the euro. ECB Executive Board member Isabel Schnabel argued that the central bank should move ahead with an interest rate increase in June, even if peace talks with Iran are successful. She highlighted that the conflict has lasted significantly longer than anticipated and that elevated energy prices are increasingly affecting the wider economy.
Market pricing indicates that investors have already factored in two increases in the ECB’s 2% deposit facility rate and assign nearly a 50% probability to a third hike over the coming year. Economists, however, are more guarded, expecting two hikes followed by a rate cut in mid-2027, according to a Reuters poll.
| ECB Policy Expectations | Market Pricing | Economists’ View (Reuters poll) |
|---|---|---|
| Number of rate hikes priced/expected | Two fully priced, nearly 50% chance of a third | Two hikes |
| Deposit rate reference level | 2% | 2% |
| Timing of first cut | Not specified | Mid-2027 |
Background: The Euro and Its Key Drivers
Role of the Euro in Global FX
The Euro is the currency for the 20 European Union countries that belong to the Eurozone. It is the second most heavily traded currency in the world behind the US Dollar. In 2022, it accounted for 31% of all foreign exchange transactions, with an average daily turnover of over $2.2 trillion a day.
EUR/USD is the most heavily traded currency pair in the world, accounting for an estimated 30% off all transactions, followed by EUR/JPY (4%), EUR/GBP (3%) and EUR/AUD (2%).
European Central Bank and Monetary Policy
The European Central Bank (ECB) in Frankfurt, Germany, is the reserve bank for the Eurozone. The ECB sets interest rates and manages monetary policy.
The ECB’s primary mandate is to maintain price stability, which means either controlling inflation or stimulating growth. Its primary tool is the raising or lowering of interest rates. Relatively high interest rates – or the expectation of higher rates – will usually benefit the Euro and vice versa.
The ECB Governing Council makes monetary policy decisions at meetings held eight times a year. Decisions are made by heads of the Eurozone national banks and six permanent members, including the President of the ECB, Christine Lagarde.
Inflation and Economic Data as Market Catalysts
Eurozone inflation data, measured by the Harmonized Index of Consumer Prices (HICP), is an important econometric for the Euro. If inflation rises more than expected, especially if above the ECB’s 2% target, it obliges the ECB to raise interest rates to bring it back under control.
Relatively high interest rates compared to its counterparts will usually benefit the Euro, as it makes the region more attractive as a place for global investors to park their money.
Data releases gauge the health of the economy and can impact on the Euro. Indicators such as GDP, Manufacturing and Services PMIs, employment, and consumer sentiment surveys can all influence the direction of the single currency.
A strong economy is good for the Euro. Not only does it attract more foreign investment but it may encourage the ECB to put up interest rates, which will directly strengthen the Euro. Otherwise, if economic data is weak, the Euro is likely to fall.
Economic data for the four largest economies in the euro area (Germany, France, Italy and Spain) are especially significant, as they account for 75% of the Eurozone’s economy.
Trade Balance and Currency Performance
Another significant data release for the Euro is the Trade Balance. This indicator measures the difference between what a country earns from its exports and what it spends on imports over a given period.
If a country produces highly sought after exports then its currency will gain in value purely from the extra demand created from foreign buyers seeking to purchase these goods. Therefore, a positive net Trade Balance strengthens a currency and vice versa for a negative balance.
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