Euro Weakens as Debt Fears and Dollar Demand Intensify

Strategists at Societe Generale point to renewed weakness in the Euro (EUR) as widening debt spreads and strong US Dollar (USD) demand push the EUR/USD exchange rate below 1.12, a level not seen since May 2025. This downward trend is far from the European Central Bank's (ECB) technical assumption of 1.16 for the years 2026-28, raising concerns about the inflation outlook and policy transmission.

The depreciation of the Euro is complicating the ECB's inflation landscape, with strategists warning that the widening spreads could become a significant issue. This divergence may prompt debates within the ECB about uneven policy transmission and the need for non-standard tools to address the divergence. The currency's deviation from the projected 1.16 level implies higher inflation, assuming stable growth and energy prices.

The weakening Euro is also expected to squeeze industrial companies and erode real disposable income for households, as oil and natural gas prices remain elevated. Strategists question how long it will take for ECB speakers to publicly support the single currency and mitigate its decline.

Speculative positioning is currently short on Euro futures, adding to the downward pressure on the currency. The fear of contagion in European debt markets has driven the Euro lower across the board, with rising yields and tightening cross-currency spreads contributing to the decline.