EUR/USD Gains Momentum as Merz’s Election Stabilizes German Politics—But Risks Linger

The EUR/USD exchange rate has edged higher in recent weeks, reaching near 1.1350–1.1370 amid the political stabilization brought by Friedrich Merz’s election as Germany’s chancellor. While the Euro’s ascent reflects reduced uncertainty in Europe’s economic powerhouse, underlying risks—from ECB rate cuts to U.S.-China trade dynamics—keep gains capped.

The Catalyst: Merz’s Election and Policy Shifts

Merz’s narrow victory in the Bundestag’s second vote for chancellor alleviated fears of prolonged political gridlock in Germany. His coalition with the Social Democrats promises fiscal stimulus via a €500 billion infrastructure fund, corporate tax cuts, and reforms to streamline bureaucracy. These measures aim to revive a German economy projected to stagnate at 0% growth in 2025.

However, skepticism remains. Merz’s strict adherence to Germany’s debt brake—limiting deficits to 0.35% of GDP—has drawn criticism from economists, who argue it stifles the flexibility needed to address structural challenges.

ECB vs. Fed: Divergent Monetary Policies

The European Central Bank (ECB) is expected to cut its deposit facility rate by 25 basis points to 2% in June, prioritizing economic stability over inflation concerns. This dovish stance contrasts with the Federal Reserve’s cautious approach, where rates remain steady at 4.25%–4.50% amid conflicting pressures from a contracting U.S. economy (-0.3% Q1 2025) and a resilient labor market.

The ECB’s focus on absorbing U.S. tariff-driven shocks has further weakened the Euro’s upside, while the Fed’s reluctance to cut rates has limited the Dollar’s decline.

Trade Tensions and Geopolitical Crosswinds

U.S. tariffs on European goods and retaliatory measures from the EU—potentially including €100 billion in tariffs on U.S. exports—add volatility to both currencies. Constructive U.S.-China trade talks have temporarily eased global risks, supporting EUR/USD. However, U.S. President Trump’s push for rate cuts and his administration’s alignment with Germany’s far-right AfD party introduce geopolitical uncertainty.

Market Sentiment and Technical Outlook

EUR/USD has held support near the 20-day EMA (~1.1270) but faces resistance at 1.1500. Traders await clarity on ECB rate decisions and U.S. fiscal-monetary policy alignment. Technical indicators suggest a neutral-to-bullish bias, though RSI readings within 40–60 indicate exhausted momentum.

Conclusion: A Fragile Euro Rally

Merz’s election has provided a modest tailwind to the Euro by reducing political risk and signaling growth-oriented fiscal measures. However, the ECB’s accommodative stance, U.S. tariff-driven economic headwinds, and legislative hurdles to Merz’s reforms cap gains.

The EUR/USD’s near-term trajectory hinges on three factors:
1. ECB Rate Cuts: A June rate cut to 2% will likely weigh on the Euro unless growth data improves.
2. Fed Policy Shift: A Fed pivot toward rate cuts—driven by further U.S. economic weakness—could weaken the Dollar and boost EUR/USD.
3. Trade Resolution: A U.S.-EU tariff truce or breakthrough in U.S.-China talks would stabilize risk sentiment and support the Euro.

For now, EUR/USD remains in a tight range (1.12–1.14), reflecting balanced forces. Investors should monitor the ECB’s June decision and U.S. Q2 GDP data for clues on sustained momentum.

The Euro’s recovery is real—but its durability depends on more than Merz’s policies alone.