The euro is heading for its worst quarterly performance since 2024—the renewed escalation in the Middle East has once again laid bare Europe’s dependence on imported energy and deepened doubts about the resilience of the region’s economic growth.
Over the quarter, the single currency has weakened by about 2%, hovering around $1.15, and in March it lost 2.5% against the dollar—the steepest decline since July. This marks a sharp reversal from late January, when the exchange rate rose above $1.20, reaching its highest level in nearly five years. In the short term, Morgan Stanley strategists led by David Adams see the euro falling to as low as $1.13.
With oil prices rising above $115 a barrel and Iran effectively closing the Strait of Hormuz, currency markets are reverting to the logic of 2022, when Russia’s invasion of Ukraine battered European markets and strengthened the dollar. Unlike the United States, which stands to benefit as a major oil producer, the European Central Bank is once again confronting a combination of energy-driven inflation and an economic slowdown.
Money markets are now pricing in three interest-rate increases this year—a sharp shift from just a few weeks ago, when a 35% probability of rate cuts was still seen as the baseline scenario. At the same time, optimism over Germany’s fiscal turn and higher defence spending has faded, the OECD has lowered its growth forecasts, and authorities in Germany and Italy are considering revising their official estimates downward.
Although higher interest rates usually support a currency when economic growth remains steady, that rule breaks down in the context of the Middle East crisis—supply constraints are undermining economic momentum. ING estimates that a pullback in overseas investment from Gulf states amid the crisis will tighten global financial conditions and hit growth-sensitive currencies hardest, including the euro.
The options market points to deeper risks than those implied by Bloomberg analysts’ forecast of $1.20 by year-end. In a matter of weeks, expectations have shifted from firmly positive to far more fragile assessments of the euro’s prospects.
Demand for protection against euro weakness hit a four-year high at the start of the month. Longer-term indicators show that traders who last year routinely paid a substantial premium to bet on euro appreciation have fully unwound those positions, leaving sentiment neutral.
There is still firm demand for hedging against euro declines versus safe-haven and commodity-linked currencies—bearish positions against the euro are almost four times larger than bets against the yen. A similar, though less pronounced, pattern can be seen in pairs involving the Swiss franc and the Australian dollar.
At the same time, the picture is not uniformly negative across all fronts.
According to Depository Trust & Clearing Corporation data for this month, market participants are paying more than four times as much for options betting on euro gains against the British pound as they are for bets on its decline.