EUR/USD slides toward 1.13 as weak eurozone growth meets steady Fed

The euro is losing ground against the dollar as a deteriorating eurozone growth outlook collides with expectations the Federal Reserve will keep rates on hold this week.

EUR/USD slipped toward 1.1350 on Thursday, extending its weekly decline, as weak eurozone growth data and expectations the Federal Reserve will hold rates steady reinforced the dollar's yield advantage.

"The euro is caught between a hawkish ECB that has already delivered its last hike and a Fed that shows no urgency to cut," said Jane Foley, senior FX strategist at Rabobank. "That divergence favors the dollar in the near term."

The European Central Bank raised its deposit rate to 2.25% last week, as expected, but President Christine Lagarde offered no clear signal on further tightening. Eurozone inflation stands at 3.2%, still above the 2% target, while the economy expanded just 0.1% in the first quarter and industrial production contracted 0.6% in April. Across the Atlantic, the Fed begins its two-day meeting Tuesday with the federal funds rate at 5.25-5.50%, where it has sat since July 2023. CME FedWatch data shows a 92% probability of a hold this week.

The policy divergence leaves the euro exposed. If the Fed delivers a hawkish hold — Chair Kevin Warsh's first meeting — and signals patience on cuts, the dollar could extend its gains, pushing EUR/USD toward 1.12. A dovish surprise that opens the door to a September cut would relieve pressure on the single currency. The next ECB meeting on July 24 offers the next opportunity for the central bank to adjust its stance.

The eurozone's growth problem is the structural weight on the single currency. First-quarter GDP of 0.1% followed a flat fourth quarter, putting the bloc on the edge of a technical recession. Germany, the region's largest economy, contracted 0.2% in the first three months of the year, while France posted zero growth. The April industrial production decline of 0.6% — worse than the 0.3% drop economists had forecast — points to continued weakness in manufacturing, the sector most exposed to global trade headwinds.

The contrast with the U.S. economy sharpens the divergence. U.S. nonfarm payrolls averaged 218,000 per month over the past three months, well above the 100,000 breakeven rate estimated by the Atlanta Fed. May CPI ran at 4.2% year over year, keeping the Fed in a holding pattern. The last time the Fed used language similar to its current guidance — emphasizing patience and data dependence — was in early 2024, preceding a 10-month stretch of unchanged rates that pushed the dollar index up 6%.

Rate Differentials Widen to 180 Basis Points

The yield gap between two-year U.S. Treasuries and German bunds has widened to 180 basis points, the most since November, reflecting the growing gulf in rate expectations. U.S. two-year yields trade near 4.19%, while the German equivalent sits at 2.39%. That spread directly supports the dollar: carry traders borrow in euros and lend in dollars, a trade that has returned 4.3% this year on a hedged basis, according to Bloomberg data.

The ECB's challenge is that inflation remains sticky even as growth stalls. Services inflation, the component most sensitive to domestic wage pressures, held at 4.1% in May, giving hawks on the Governing Council ammunition to resist rate cuts. Markets price 38 basis points of ECB easing by year-end, implying roughly one quarter-point cut and a 50% chance of a second. That compares with 45 basis points of Fed cuts priced over the same period — a gap that has narrowed in recent weeks as U.S. data softened slightly.

The immediate catalyst is the Fed decision Wednesday. Warsh, a former Fed governor appointed by President Trump, has signaled a preference for data-dependent policy but has not tipped his hand on the rate path. The updated dot plot — the individual rate projections from 19 Fed officials — will show whether the median estimate for 2026 cuts has shifted from the two penciled in at the March meeting. A reduction to one cut or none would be a hawkish signal that could push EUR/USD below 1.13. Maintaining the two-cut median would validate current market pricing and give the euro room to stabilize.

Beyond this week, the eurozone calendar offers few catalysts for a rebound. The July 24 ECB meeting is the next scheduled policy event, and Lagarde has given no indication of an inter-meeting move. Until the growth data improves or the Fed signals a clear easing bias, the path of least resistance for EUR/USD is lower.

This article is for informational purposes only and does not constitute investment advice.