Geopolitics and trade policy move the currency markets
Donald Trump’s aggressive tariff policy, the associated inflation concerns and the prospect that the Fed has little room for further interest rate cuts had given the dollar a significant tailwind at the beginning of the year. Recently, however, the tide has turned. On the one hand, the currency market, among others, seems to be increasingly asking itself how many allies and trading partners President Trump can take on at the same time without also damaging the US economy in the medium term.
Strength of the dollar wanes since beginning of the year
Nominal effective exchange rates
On the other hand, the new geopolitical realities have finally shaken Europe out of its complacency. In Germany and at the EU level, defence spending will increase significantly in the coming years. In addition, Germany will establish a EUR500bn special fund for infrastructure investments. These fiscal stimuli will strengthen growth, but also increase debt. The bond markets and the currency markets are reacting to this development; the euro gained significant ground against the dollar at the beginning of March. The ongoing economic recovery in the eurozone and the sense of a new dawn in Germany should continue to support the single currency in the coming months. However, a lot will also depend on the further development of the trade disputes between the US and Europe, which are likely to contribute to ongoing volatility.
Fiscal stimulus boosts Euro
Euro exchange rates
In Switzerland, inflation in February was 0.3% year-on-year, the lowest level in almost four years. The Swiss National Bank is trying to counteract low inflation and the strong franc, but after the key interest rate cut on 20 March from 0.5% to 0.25%, the scope for further easing of monetary policy is limited. Direct intervention in the currency market would be an alternative, but this in turn carries the risk of the US labelling it a currency manipulator. However, since the ECB is also only likely to lower its key rate slightly this year, we expect the euro-franc exchange rate to move sideways in the medium term, roughly at the current level.
In Japan, the economy is picking up momentum and inflation continues to rise. This allows the Japanese central bank to cautiously continue its cycle of interest rate hikes. The narrowing interest rate differential with the ECB and the Fed should give the yen further tailwind this year. We expect a euro/yen exchange rate of 154 by the end of 2025.
Exchange rate forecasts
Berenberg and consensus forecast in comparison, values at the end of 2025 and mid-2026
Author
Dr. Felix Schmidt
Senior Economist