Lagarde sees opening for euro as dollar reserve dominance wavers

Christine Lagarde used a speech at the Hertie School in Berlin this week to argue that the geopolitical upheaval triggered by US trade policy has cracked open a window for the euro to expand its role in the global monetary system. The European Central Bank president did not promise success, she said closing the gap with the dollar was "far from guaranteed", but she laid out a three-pillar strategy that would, in her view, allow the currency to "earn" greater international influence.

The numbers frame the challenge. The US dollar accounts for almost 60% of global foreign exchange reserves, according to IMF data, while the euro sits a distant second at roughly 20%. The dollar index, which measures the greenback against a basket of major peers, has fallen more than 8% since January. Over the same period the euro has risen over 9% against the dollar, trading around $1.13 on Friday. For Lagarde, the shift is not merely cyclical; it reflects a structural repositioning as "multilateral cooperation is being replaced by zero-sum thinking and bilateral power plays."

Three pillars for a stronger international euro

Lagarde's first condition is geopolitical. Europe must maintain a "steadfast commitment to open trade" and underpin it with credible security capabilities. The implication is clear: a currency aspiring to reserve status needs a sovereign issuer that can guarantee the safety of the trade routes and legal frameworks on which cross-border commerce depends. Today the EU relies heavily on US security guarantees through NATO, a dependency that limits the euro's autonomy in moments of great-power tension.

The second pillar is economic. Lagarde called for "deeper and more liquid capital markets" to make Europe a top destination for global capital. This is a long-standing ambition, the capital markets union has been on the EU agenda for a decade, but progress has been glacial. National supervisory barriers, fragmented insolvency regimes and the absence of a true euro-area safe asset comparable to US Treasuries keep the euro's financial plumbing narrower and shallower than the dollar's.

The third pillar is legal and political. Defending the rule of law and uniting politically so that Europe can "resist external pressures" is, in Lagarde's framing, a prerequisite for monetary credibility. The euro's history is punctuated by crises in which national interests clashed with collective discipline, Greece in 2010-15, Italy's budget disputes with the Commission, Hungary and Poland's rule-of-law conflicts. Each episode reminds reserve managers that the euro is ultimately a political construct, not merely a monetary one.

What a reserve upgrade would buy Europe

Lagarde enumerated concrete benefits: lower borrowing costs for euro-area governments, insulation from exchange-rate volatility, and protection from sanctions or "other coercive measures." The last point is pointed. The dollar's dominance gives Washington extraterritorial leverage, secondary sanctions, the ability to cut off access to dollar clearing, that Brussels has no equivalent for. A more widely used euro would dilute that leverage, giving the EU greater strategic autonomy in foreign policy.

"In short, it would allow Europe to better control its own destiny," Lagarde said. The phrase echoes the strategic autonomy language that has gained traction in Paris and Berlin since the first Trump administration, but it now carries the weight of the ECB's institutional voice.

Schnabel echoes the opportunity narrative

Lagarde is not alone on the Executive Board. Last week Isabel Schnabel told an audience that the euro area could become a safe haven as US tariff policies take hold, handing the region "a historical opportunity to foster the international role of the euro." The language is deliberate: safe-haven status is what transforms a regional currency into a global reserve asset. Investors park reserves where they believe capital will be preserved in a crisis. For decades that has meant US Treasuries; the question is whether euro-area sovereign debt, or a future common safe asset, can credibly offer the same depth and liquidity.

Market views split on the euro's trajectory

Analysts contacted by CNBC were divided. George Buckley, chief European economist at Nomura, said he could see "upside ahead for the euro" as investors look to diversify away from the dollar. "Certainly to some extent" he agreed with Lagarde's assessment. "The dollar still is the biggest reserve currency in the world … the euro is still a distant second, but it's gaining in momentum quite significantly with all the things going on in the US." Buckley forecasts the euro could reach $1.20 by year-end, a further 6% appreciation from Friday's level.

Aaron Hill, chief market analyst at FP Markets, took the opposite view. "The euro, while backed by the European Union's substantial economic weight, faces significant hurdles," he said. "Political fragmentation across member states and reliance on US security frameworks limit its global influence." Hill added that those limitations were "unlikely to evaporate any time soon" and that "the greenback's reign endures, unshaken."

John Plassard, senior investment specialist at Mirabaud Group, was blunter: with the dollar at almost 60% of reserves, there is "no competition for the US dollar" right now. The gap is not merely large; it is structural. Reserve managers do not shift allocations quickly. They require depth, liquidity, and a track record of stability, attributes the dollar has built over eight decades.

The capital markets gap remains the hardest to close

The divergence between the optimists and the sceptics centres on whether Europe can deliver the second pillar, deeper capital markets, without first solving the first and third. A genuine capital markets union requires a common deposit insurance scheme, harmonised insolvency law, and a fiscal backstop for a euro-area safe asset. Each of those demands political risk-sharing that national governments have repeatedly resisted. The European Commission's latest push for a savings and investments union, unveiled in 2024, attempts to restart the process, but the legislative pipeline is crowded and the political calendar tight.

Meanwhile, the euro's existing reserve share has been remarkably stable. IMF COFER data show the euro's portion of allocated reserves has hovered between 19% and 21% for the past five years, despite the ECB's negative-rate era, the pandemic, and the energy shock. Stability is a virtue for a reserve currency, but it also suggests that incremental improvements in governance have not translated into a structural shift in reserve managers' preferences.

Security dependence constrains monetary autonomy

The geopolitical pillar is equally intractable. The EU's security architecture is built around NATO, and the war in Ukraine has deepened, not reduced, European reliance on US intelligence, air defence and nuclear deterrence. French President Emmanuel Macron has long argued for European strategic autonomy, but German Chancellor Olaf Scholz's government has been cautious, preferring to strengthen the transatlantic pillar. Until Europe can credibly guarantee the security of its eastern flank and its energy supply lines without US enablers, the euro's reserve appeal will carry a geopolitical discount.

What happens next

The next test is not a speech but a negotiation. The EU's 2025-2027 legislative cycle will determine whether the savings and investments union advances beyond consultation papers. The ECB's own balance sheet, still swollen by pandemic-era asset purchases, limits its room for manoeuvre if markets test the euro's credibility. And the US election cycle, while not a European decision, will shape the external environment: a second Trump term or a protectionist Democratic administration would keep the pressure on the dollar, but also on the EU's export model. For now, Lagarde has framed the opportunity. Whether Europe's capitals act on it is a political choice, not a monetary one.