The euro’s strong performance earlier in the year is facing a more complicated environment as higher energy prices and political uncertainty weigh on the currency. After moving toward $1.20 in August, the euro has retreated roughly 2% this month and recently traded near $1.137, its weakest level in about two months.

The dollar has also benefited from a renewed perception that U.S. monetary policy remains focused on containing inflation. A rate increase has strengthened expectations that the Federal Reserve may maintain a hawkish stance, creating additional support for the dollar as investors reassess the relative outlook for the U.S. and euro-zone economies.

Political Risk Adds Pressure

Europe’s political landscape is becoming another factor for currency markets. Germany is facing uncertainty after strong results for the far right in recent state elections, potentially complicating Chancellor Friedrich Merz’s reform agenda. France is confronting separate concerns surrounding elevated public debt and political gridlock ahead of its 2027 presidential election.

Financial markets are already reflecting some of these concerns. The premium investors demand to hold French 10-year government bonds over highly rated German debt has risen above 110 basis points. According to estimates cited in the source, every additional 10-basis-point widening could correspond with an approximately 0.4% decline in the euro against the dollar.

Energy Shock Complicates the Economic Outlook

Energy prices may represent the more immediate challenge. The conflict in the Middle East has disrupted liquefied natural gas shipments through the Strait of Hormuz, pushing European gas prices above €80 per megawatt hour, their highest level since late 2022.

Higher energy costs could weigh on European households and businesses while increasing inflationary pressure. That combination creates a difficult environment for the euro because stronger inflation may encourage tighter monetary policy, while simultaneously weakening economic growth. Analysts cited in the source argue that European gas prices would need to ease meaningfully for the euro to regain its previous upward momentum.

Oil Prices Could Become Another Currency Driver

The outlook could become more challenging if crude prices rise further. ING strategist Francesco Pesole said oil approaching $115 per barrel would increase pressure on the euro by intensifying concerns about economic growth. A potential U.S. restriction on diesel exports was also cited as a possible additional complication, although it was not considered the primary scenario.

At the same time, the euro still has factors working in its favor. Markets are pricing in at least one additional euro-zone rate increase this year, while the region’s economy has demonstrated greater resilience than some earlier expectations suggested. If European central banks remain hawkish, the currency could receive support even as energy prices remain elevated.

What Could Determine the Next Move?

The euro’s next major direction may depend on whether energy prices stabilize, European political risks remain contained and monetary policy continues to favor the currency. If European gas prices remain elevated in the €85–€100 range cited by analysts, the euro could face renewed downside pressure. Conversely, easing energy costs combined with persistent central-bank tightening could provide a foundation for stabilization.

For investors, the key signals to monitor are European gas and oil prices, French-German bond spreads, expectations for euro-zone interest rates and developments in Germany and France. These factors could determine whether the euro’s recent decline becomes a temporary correction or develops into a more prolonged period of weakness against the dollar.