The euro generally reacts negatively to geopolitical shocks that push energy prices higher. After Israel’s strike on Iran, the euro weakened against the Japanese yen and Swiss franc.
This move triggered a sell-off of long euro positions against the US dollar, which had been overvalued according to ING’s FX analyst Francesco Pesole.
Pesole’s model showed the euro was briefly about 5% overvalued against the dollar, a peak level.
For the euro to rally further, there would need to be a clear shift in interest rates—either higher short-term rates in Europe or lower rates in the US—or a major worsening in the US debt market. After the recent correction, the overvaluation dropped to around 4%.
The recent oil market volatility supports the European Central Bank’s cautious stance on further rate cuts.
ING expects the ECB’s last 25 basis points rate cut of this cycle to come later in the year, likely in the fourth quarter rather than the third, matching current market expectations.
Given the fast-changing geopolitical situation, it is too early to draw firm conclusions on monetary policy. The EUR/USD exchange rate will likely track developments mainly through the oil price channel.
ING believes the euro’s recent high levels were already stretched, and a return to the 1.14-1.15 range now looks reasonable.
