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.

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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.

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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.

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EUR/USD in 2025: Economic Divergence Between the US and Eurozone Expected to Grow

In addition to the anticipated two rate cuts in 2025, the Federal Reserve has raised its GDP growth forecast for 2024 to 2.5%, up from the 2% projected in September, attributing this to strong economic activity. However, growth is expected to return to a long-term trend of 1.8% starting in 2026.

Inflation projections were also revised upwards, with the 2025 forecast increasing to 2.5% from 2.1%, and core inflation now expected to be 2.8% for the same year.

Meanwhile, the European Central Bank (ECB) is expected to further reduce rates in 2025 due to ongoing weak growth and declining inflation. Some analysts have even speculated that rates could dip below the 2% neutral level, although this remains unlikely.

The ECB’s latest macroeconomic projections showed downward revisions in inflation estimates, with headline inflation expected to be 2.1% and core inflation at 2.3%, both aligning at 1.9% by 2026. Growth forecasts have also been lowered, with 2025 projected at 1.1% and 2026 at 1.4%.

In summary, the Federal Reserve faces inflationary risks to the upside, while the ECB is confronted with an economic downturn, compounded by local political instability, which poses a significant challenge.

EUR/USD technical outlook:

The EUR/USD pair is finishing its third consecutive month in the red, and technical analysis on the monthly chart suggests that 2025 could be a challenging year for the Euro. For most of the past two years, the pair traded above its 20 Simple Moving Average (SMA), but it fell below this level in November. The 100 SMA has consistently acted as a strong dynamic resistance, preventing buyers from pushing past the 1.1200 level during this period. Additionally, technical indicators have crossed their midlines and show persistent bearish trends, indicating the likelihood of further declines. Below the 1.0330 price level, there is minimal support before reaching the 1.0200 mark, and a test of parity is possible if the pair falls further.

On a weekly timeframe, technical indicators suggest the EUR/USD pair is likely to continue making lower lows before any potential upward correction. The indicators are firmly pointing south and approaching oversold levels, though there are no signs of downward exhaustion yet. The chart also reveals that the 20 SMA is gaining downward momentum and is close to crossing below the flat 100 SMA, both well above the current price, which typically signals strong selling pressure.

While the bearish scenario appears to be the most probable, it is not the only possibility. If the pair reverses direction due to a resurgence in the EU economy and a sudden slowdown in the US economy, the pair could first target the 1.0600 area. A sustained macroeconomic imbalance favoring the EU might push the EUR/USD pair towards the 1.1000 level, though this outcome is unlikely to occur in the first half of the year.

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Conclusion

The macroeconomic outlook favors the USD over the EUR, as economic developments are expected to take precedence, even amid inflationary pressures. While a potential return of Trump to the presidency could bring increased inflation-related risks for the US, the country demonstrated the strongest recovery from the pandemic within the G7, as measured by GDP. This recovery began during Trump’s presidency and continued under Biden’s administration, even with the challenges posed by the coronavirus. While the potential return of Trump to the presidency may introduce heightened inflation-related risks, the underlying economic momentum of the US remains a key strength. This resilience and adaptability position the USD as the favored currency, underscoring the primacy of economic fundamentals in shaping the broader macroeconomic outlook.