The euro fell to its lowest level since 13 August against the US dollar after the release of the Federal Reserve meeting minutes on Wednesday.
The minutes revealed that Federal Reserve officials were divided on whether a 0.5% rate cut was necessary, signalling a slower pace in future rate reductions, which in turn bolstered the US dollar.
Since the end of September, the euro has declined by 2.3% against the dollar, dropping from 1.12 to just above 1.09.
The euro's weakness is expected to persist in the lead-up to next week's ECB policy meeting, where the bank is anticipated to deliver its third rate cut of the year.
Shifting Expectations for the ECB and the Fed
The euro's recent strength against the dollar has been influenced more by the Federal Reserve's decisions than by the ECB's.
In September, the Federal Reserve initiated its easing cycle with a substantial rate cut, sending the US dollar lower and pushing the euro to a near three-month high.
However, in October, this trend reversed as market participants began to anticipate a softer rate cut by the Fed and a more dovish stance from the ECB.
This shift in expectations for the future rate paths of the Fed and the ECB is likely to keep the euro under pressure.
The Fed’s 0.5% rate cut, which was in response to a slowdown in the US labour market, may have been overestimated. Non-farm payroll data had shown slower employment growth and a rising jobless rate.
However, the September jobs report eased concerns as job creation exceeded expectations and unemployment decreased. The Fed used the term "recalibration" in its meeting minutes, suggesting that the large rate cut was, in part, a response to delayed decisions compared to other central banks.
The minutes also noted: "Some participants observed that they would have preferred a 25 basis point reduction of the target range at this meeting, and a few others indicated that they could have supported such a decision."
Fed fund futures now indicate a quarter-percentage-point cut is expected in both the November and December meetings, rather than a half-percentage-point reduction.
Following the meeting, the US government bond yields climbed, with the benchmark 10-year treasury yield rising to 4.07%, the highest seen in July, likely to continue to drive the uptrend of the dollar.
Dilin Wu, research strategist at Peperstone, told Euronews: "Combined with rising US Treasury yields and a widening rate differential with G10 counterparts, this underpins the dollar’s strength."
In contrast, the ECB may adopt a more dovish tone due to weakening economic data and cooling inflation.
Wu added: "The ECB seems more likely to have a dovish stance while remaining data-driven."
According to Eurostat's flash estimate, the Eurozone Consumer Price Index (CPI) fell to 1.8% year-on-year in September, below the ECB’s 2% target and down from 2.2% in August.
Germany, the Eurozone's largest economy, continues to struggle with a manufacturing downturn, as indicated by the sharp drop in ZEW Economic Sentiment, which fell to 3.6 in September, the lowest since October 2023.
"The economic outlook appears increasingly fragile," she said, referring to the eurozone's economic outlook.
While the ECB implemented a hawkish rate cut in September and stated it was "not pre-committing to a particular rate path", recent weak data has led to market expectations shifting towards a more likely quarter-point rate cut next week, rather than no change.
Euro Faces Challenges Amid Rising Middle East Tensions
The ongoing conflict in the Middle East could also weigh heavily on the euro due to the potential for rising energy prices.
Since Russia invaded Ukraine, the Eurozone has been grappling with a surge in the cost of living and economic stagnation.
A similar scenario could unfold if the Middle East conflict escalates into a broader regional war.
Meanwhile, the US dollar is likely to be seen as a safe-haven asset, given the geographical distance of the US from the conflict zone, coupled with its resilient economy.
The European Union is also facing internal political uncertainty, with the rise of far-right movements in France and Germany.
Additionally, tensions with China over tariffs on Chinese electric vehicles and potential retaliatory measures present further challenges for the region's economy. As a result, the euro is likely to remain under pressure for the foreseeable future.