2026 begins with quite a headache for the European Central Bank (ECB), called in exactly one week to decide on interest rates for the first time in this new year. Christine Lagarde bid us farewell in December with the same phrase that she now repeats from board to board: “future decisions will be based on data”. Once the era of Draghi’s “forward guidance” is over, the institute is not bound to stick to any pre-established path. And the data points to a strong euro against the dollar, to the point that the exchange rate rose to its highest levels since 2021. Yesterday, it broke through the 1.20 threshold.
Strong euro helps fight inflation
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A strong euro helps the process disinflation of the economy in the Eurozone that the ECB is aiming for. Already in December the 2% target was achieved again after inflation rose above this threshold during the autumn. The appreciation of the exchange rate allows our companies to import products and services from abroad at lower costs. This is one side of the coin. Its downside concerns the possible decline in exports: our goods cost more outside the area. A problem for exporting economies like Germany and Italy. The Eurozone itself overall closed 2024 with a trade surplus equal to 1.2% of GDP.
If it were just this, it would be a physiological fact. Consider that the euro-dollar exchange rate it came close to 1.60 in 2007 and again 1.40 in 2014. In 2022 it would have fallen to its lowest level since 2002, i.e. below parity and 0.96. Rather than a strong euro in an absolute sense, we should talk about a slow return to normality.
Between the sovereign debt crisis, the pandemic and the war, the single currency has lost much appeal on international markets. Instead of placing the dollar alongside the dollar as the world’s reserve currency – this was the ambition of the early 2000s – its share in foreign exchange reserves has remained almost identical to that of the early 1990s, when there were 12 member states in the monetary union compared to the current 21.
Damn to exports after US tariffs
The trouble for the ECB is that the strengthening of the euro comes after the increase in American duties on European goods. The general tariff rose to 15%, making our exports to the United States more than three times more expensive. And this is the main outlet market for community goods. The strong euro appears as a second duty and raises fears of a collapse of the continental economy after the extraordinary resilience shown last year.
Energy prices falling sharply
And in the meantime, interesting things are happening on the energy market: Brent costs us in January on average between 18% and 19% less (in dollars) compared to a year ago. Gas on the Amsterdam Stock Exchange fell year-on-year by around 30%. With a euro-dollar exchange rate that has jumped by 15% in a year, we are witnessing a trend collapse in the effective cost of energy in the order of 30%. This contributes to disinflation, which is great news for consumers after years of high bills, but from the ECB’s point of view it increases the risk of inflation “subdue”too low.
ECB rate forecasts remain cautious
There will almost certainly be no interest rate announcement on February 5th. They will remain unchanged at 2% on bank deposits. And the market still does not expect any upside between now and the summer of next year. The derivative contracts with the object ofEuribor is the 3 mesiwhich follows the trend of ECB rates.
Following Frankfurt’s logic, we will have to wait for the inflation data for the first months of the year to understand what its reaction will be. A decline in inflation well below 2% and considered “non-transitory” would bring a further rate cut closer. The same would apply if GDP in the Eurozone in the fourth quarter of 2025 and the first quarter of this year turns out to be weak or declining. The problem remains geopolitical unpredictability at this stage, with the Trump administration dismantling all the certainties on which the global order was based in recent decades after the fall of the Soviet Union.
Euro stronger with FED case
If the Federal Reserve showed signs of giving in to pressure from the White House by cutting rates, the dollar would continue to depreciate and the euro would become even stronger. At that point, the ECB would almost be forced to react to cushion theimpact of the exchange rate on the economy. A scenario that would not displease governments: they would refinance debts and issue new ones at lower costs and appease the anger of their citizens against the high cost of living. And lower rates would facilitate business investments and credit to families, i.e. consumption. Both are essential to relaunch domestic aggregate demand and loosen dependence on exports.
giuseppe.timpone@investireoggi.it
