The euro area is stuck in a deepening economic quagmire. An export-dependent and manufacturing-heavy growth model is coming under strain as geopolitical tensions keep energy prices elevated, China moves up the value chain and dumps excess industrial capacity into the rest of the world, and the US becomes more isolationist. Domestic political dysfunction is worsening, productivity growth is sluggish, and growth remains lacklustre, trailing far behind the US. 

Against this backdrop, the odds are stacked against the common currency. The European Central Bank, responding to deteriorating growth and inflation prospects, is seen slashing rates to 2% or lower in the year ahead, widening already-unfavourable interest rate differentials. Sentiment is almost universally bearish, with many observers expecting the exchange rate to fall below parity on a sustained basis. 

European uncertainty levels are still climbing.
Economic Policy Uncertainty Indices, 12-month rolling averages
January 1999 – November 2024

But crisis can create opportunity. Shocked out of complacency by Trump’s trade and security threats, leaders could finally begin boosting defence and infrastructure investment, delivering some form of fiscal stimulus. With a similar dynamic playing out in China, exports may rebound. In turn, this might provide the sentiment improvement needed to release real wage gains and unlock pent-up consumer spending. And an easing in the war in Ukraine could boost the euro—defying the current consensus.

Wage growth is accelerating.
Annual % change in negotiated wages
Q1 1999 – Q3 1999