Euro climbs 14 percent as US policy uncertainty erodes dollar reserve status

The euro has appreciated roughly 14 percent against the US dollar since the start of 2025, a move that has wrong-footed many market participants because it arrived while the European Central Bank was cutting interest rates and the Federal Reserve was holding them steady. The scale and persistence of the advance prompted a unusually frank discussion among euro-area central bankers at an economic forum in Aix-en-Provence last week, where officials from the ECB, the Bank of Greece, the Central Bank of Ireland and the Eurogroup argued that the currency's gains reflect something more structural than a cyclical interest-rate differential.

Aix-en-Provence forum exposes a shifting consensus

Speaking on a CNBC-moderated panel on Saturday, Yannis Stournaras, governor of the Bank of Greece, connected three distinct US policy strands, tariffs, political pressure on the Federal Reserve and a tax-and-spending bill expected to swell the federal deficit, to explain the dollar's recent trajectory. "If you combine [U.S.] tariffs with the attacks on the Fed and institutions, with the fiscal sustainability of the United States following the 'beautiful' tax bill, it explains the evolution of the dollar exchange rate in the recent weeks," he said. Stournaras added a blunt assessment of the tariff mechanism: "Those who impose tariffs will be hurt first."

Gabriel Makhlouf, governor of the Central Bank of Ireland, offered a complementary diagnosis. He characterised the dollar's decline as a "realignment, a readjustment on the part of investors" driven less by tariff headlines than by a perception that the rule of law in the United States is weakening. "Investors are seeing the rule of law in the United States actually weaken and they are responding accordingly, because that means there's a greater risk to their investments and their assets, and they're adjusting," Makhlouf said. The distinction matters: if the move is a repricing of institutional risk rather than a reaction to trade barriers, it is less likely to reverse quickly even if a US-EU trade deal materialises.

Reserve currency data confirms a decade-long drift

The anecdotal shift is visible in the official numbers. According to an ECB report published in June, the US dollar's share of global foreign exchange reserves slipped from 68.8 percent in 2014 to 57.8 percent by the end of 2024. The euro's share has hovered around one-fifth for more than a decade, neither gaining nor losing ground in aggregate. The exact impact of 2025 flows is not yet clear, but the direction of travel is consistent with what the Aix-en-Provence panellists described: a gradual diversification away from the dollar that has accelerated this year.

Paschal Donohoe, president of the Eurogroup, emphasised that the euro's growing role in international reserves will not happen automatically. He pointed to the NextGenerationEU stimulus as a structural driver of euro-denominated borrowing in the years ahead. "The key thing for us is how we can have strong foundations in place for the euro," Donohoe said, citing stability as the most important factor. The Eurogroup's own work programme treats deepening the currency's international use as a deliberate policy objective rather than a by-product of US missteps.

Banking Union and Capital Markets Union remain unfinished

Stournaras was explicit about the prerequisites for the euro to capture a larger slice of global reserves: the EU must complete its longstanding efforts to form a Banking Union and a Capital Markets Union and reduce internal barriers that fragment the euro-area financial system. Without them, the currency's appeal as a stable alternative hits a ceiling. The Banking Union still lacks a common deposit insurance scheme, a sticking point since 2015, while the Capital Markets Union has progressed in fits and starts, hampered by national vetoes on insolvency law harmonisation and supervisory convergence. These are not new observations, but the current dollar weakness gives them renewed urgency.

Market mechanics: foreigners stop buying, not selling

A July 1 note from Deutsche Bank strategists George Saravelos and Christian Wietoska framed the dollar's problem in balance-of-payments terms. "Foreigners are no longer buying enough dollar assets to finance America's huge current account deficit," they wrote. "Foreigners don't need to sell U.S. assets to weaken the dollar but merely to say 'no thank you' to buying more. This continues to be the message of the various high-frequency dollar flow metrics we have." The distinction is analytically important: a buyers' strike is harder to reverse than a sellers' panic because it reflects a portfolio allocation decision rather than a fire sale. The US current account deficit, which widened to $1.13 trillion in 2024, requires continuous foreign inflows; if those inflows slow, the dollar must fall to clear the market.

Dollar fragility tested by geopolitics

Francesco Pesole, an FX strategist at ING, provided a real-time illustration of the dollar's altered behaviour. In a June 26 note he observed that a spike in geopolitical risk and oil prices, traditionally a catalyst for dollar haven demand, produced only a small and temporary bounce. "It's true that the highly efficient forward-looking FX market never really traded the big risks of a prolonged conflict and sustainably higher energy prices. But that was at least partly due to widespread aversion to holding dollars due to medium-term considerations," Pesole wrote. Those medium-term considerations, he listed, include fiscal concerns, political threats to Federal Reserve independence, and the possibility of an earlier-than-expected Fed rate cut.

Trade deal uncertainty adds a layer of volatility

As of Monday, the status of a potential US-European Union trade deal remains in limbo, with an update expected over the coming days. The template from Washington's early agreements, with the United Kingdom and Vietnam, suggests that White House duties will be broadly higher on all goods entering the United States than they were at the start of the year, even if lower than the rates threatened in April. That baseline shift matters for European exporters, but the Aix-en-Provence consensus was that the euro's trajectory is now driven more by capital-flow dynamics than by trade-flow expectations. A deal might remove a tail risk for the euro, but its absence is no longer the primary driver of EUR/USD.