Euro Tumbles to 16-Month Low as Energy Shock and ECB Caution Collide

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The euro plunged to a 16-month low against the dollar this week, capping its worst month in more than a year as soaring energy prices, political uncertainty in Europe, and a widening monetary-policy gap between the Federal Reserve and the European Central Bank batter the single currency.

Diverging Central Banks Drive Selloff

The EUR/USD pair fell to $1.1310 on Tuesday before edging back toward $1.135 on Wednesday, leaving the euro down roughly 2.3% for September — the dollar’s strongest monthly advance against the single currency in 14 months, according to Reuters. The decline has put the dollar on course for a third consecutive quarterly gain against the euro.

The selloff reflects a growing divide between monetary policy in Washington and Frankfurt. The Fed raised interest rates earlier this month for the first time in three years, and traders had priced in as much as a 70% probability of another hike in October. That expectation eased to around 44% on Wednesday after New York Fed President John Williams said there was “no need for urgency” in raising rates again.

On the European side, the ECB also hiked rates by 25 basis points in September, but President Christine Lagarde signaled a more cautious approach. ECB policymaker Peter Kazimir echoed that message, saying the bank had “room to remain flexible.” Markets now expect the ECB to hold rates steady in October.

The result is that U.S. Treasury yields have surged to levels not seen in over a decade — the 10-year yield climbed above 5.2% this month — pulling capital toward dollar-denominated assets and away from the euro.

Bond Market Strain and Energy Woes

Eurozone bond yields also spiked before easing Wednesday. Germany’s 10-year yield fell 4 basis points to 3.57% after touching 3.65% on Monday, its highest since 2009. France’s 10-year yield dropped 3 basis points to 4.78% but remained more than 60 basis points higher for the month — the sharpest monthly increase since December 2022, with domestic political gridlock adding to borrowing costs.

Elevated energy prices, with Brent crude trading near $100, have intensified concerns about sticky inflation across the eurozone while weakening the growth outlook. Europe’s limited exposure to the artificial intelligence investment boom that has bolstered U.S. output expectations has further widened the gap between the two economies.

Inflation Data in Focus

Wednesday’s core PCE reading — the Fed’s preferred inflation gauge — came in softer than expected, with the year-over-year figure at 3.0% versus forecasts of 3.3%. The data could temper dollar strength if it reinforces the case that the Fed can afford to pause. Commerzbank analyst Thu Lan Nguyen cautioned that the dollar’s rally may already be “over-stretched even relative to developments in the euro area-US interest rate differential.”

Friday’s U.S. non-farm payrolls report will offer the next test of whether the divergence trade has further room to run.