The outlook for the euro and the British pound amid rising US tariffs

Europe’s major currencies strengthened significantly against the dollar in early 2025 as a worsening US economic outlook caused portfolio investments to diversify towards Europe and the UK relative to the US. 

“We think dollar weakness is likely to extend — in large part because US policy shifts, including tariffs, have raised uncertainty and are likely to weigh on US economic growth, corporate earnings, and consumer sentiment,” says Kamakshya Trivedi, head of Global Foreign Exchange, Interest Rates, and Emerging Markets Strategy Research at Goldman Sachs Research. “That combination, alongside the fact that people are over-allocated to US assets, means that there is a shift taking place that benefits other currencies — chiefly the euro, but also the pound,” he adds. 

The euro has strengthened 9.8% relative to the US dollar in the year to date (as of May 5). The pound has also gained 6.6% relative to the dollar in the same period.

In addition to a rethink of the return and risk prospects of US assets, Trivedi says, the gains in the euro and the pound are likely driven by more optimism about Europe and the UK. In particular, he points to the prospect of higher fiscal spending in Germany following the government’s reform of the country’s debt brake, which prompted our economists to upgrade their growth forecasts for Europe’s economy. 

“It\’s not just that you\’ve had an erosion of US return prospects. It’s also the case that there is more optimism about European fiscal spending and the potential for Europe to provide alternative safe assets that people can invest in,” Trivedi says. 

Goldman Sachs Research expects this trend to continue, with the euro forecast to be worth $1.20 and the pound projected to be worth $1.39 in 12 months, up from $1.13 and $1.33 currently (as of April 29). 

We spoke with Trivedi about the outlook for the euro and the pound. 

How rare is it that a major currency strengthens to this extent against the dollar?

The starting point is that we\’ve had many years of dollar strength, and so the dollar is quite overvalued on most conventional metrics and has been for many years. But Goldman Sachs Research has long been of the view that the dollar’s overvaluation would persist as long as US equity markets continue to deliver strong returns and US bonds continue to offer a very attractive package of high yield alongside value as a hedge for private-sector portfolios. 

The present moment is particularly noteworthy because both of those aspects are being questioned: The lower growth expectations for the US economy are likely to translate into lower company earnings, and people are questioning the return prospects of US equities. Also, some of the unusual correlations that we\’ve seen between US equities and bonds has meant that people have been questioning the hedge value of US bonds within multi-asset portfolios.  

On the other hand, after many years where flows from within Europe have been allocated to US equities and US bonds, often currency unhedged, we’re now seeing a bit of a reversal where people are more optimistic about the return and earnings prospects in Europe. 

At the same time, German and even UK government bonds have actually performed better as hedge instruments through the month of April.  

In other words, after many years of US assets being pre-eminent, we’re starting to see a shift. A lot of both European and global investors have huge allocations to the US. That imbalance has been built up over a number of years, and it will take a long time to reverse. This shift is just beginning to happen, and I think it has room to run. 

And so, while there has been a large move in the euro versus the dollar, based on Goldman Sachs Research’s metrics, the euro is still a long way away from its fair value. 

What’s driving the strengthening of the British pound?

In late 2024 and early 2025, we saw the pound strengthening not just against the dollar, but also against the euro. In part, that was because the Bank of England\’s rate easing path looked more hawkish than what was likely to play out in Europe. The combination of slightly stickier inflation and growth meant that the Bank of England was proving to be a hawkish outlier. That — alongside relatively resilient economic data — is part of the reason why the pound performed well on a broad basis. 

More recently, the euro has been on the front foot. It’s been the primary gainer versus the dollar in recent weeks, but the pound has gained as well. 

This also reflects the fact that the UK is somewhat less exposed to trade tensions than many other economies. The UK doesn’t have a particularly large goods trade imbalance with the US. Any exposure that it does have comes more from the fact that it\’s an open economy, so it\’s exposed to slower growth in the rest of the world, including in the euro area. 

What would a recessionary economic outlook for Europe and the UK mean for the euro and the pound?

Currencies are a relative asset at the end of the day: It\’s not just about 
what’s happening in one place. For one currency to appreciate, you normally need to see better relative growth and asset market prospects in that part of the world. 

And so if the economic data become significantly worse in Europe compared with the rest of the world, I think you would see some correction from the very sharp moves that we have seen in the euro and pound versus the dollar.

In general, as global investors are “right-sizing” their exposure to Europe and the UK relative to the US, there\’s probably some degree of growth slowdown or bad economic data that investors are willing to stomach. But of course, ultimately it will be about the return prospects of the assets in the region. If Europe can\’t deliver stronger growth and better returns, I think that will limit the potential extent of euro strength. 

A recessionary outlook in Europe or the UK is an important risk. But I wouldn\’t overstate that. Goldman Sachs Research expects growth to slow in both Europe and the UK, in part reflecting the tariff shock that I think everyone faces to some extent. But there\’s also been some better hard data more recently, whether it\’s consumer retail sales in the UK or some of the front-loading that\’s supported industrial production in Europe. And so the starting point here in both economies from the hard data standpoint may not be as bad as some people worry about. 

How do interest rate differentials feed into currency prices, and how is that affecting the current situation?

Interest rate differentials matter to currencies because they affect the relative yields on offer in fixed-income instruments. It\’s generally been the case in recent years that US bond markets offered both the highest yields and also the ability to hedge your risky exposure. That combination was a very attractive one for investors. 

But I would not overstate this relationship. For one thing, currencies are a forward-looking asset, so it’s generally changes in interest rates — rather than levels — that matter most, especially in developed market currency pairs like this where the differential is typically not that large. But more importantly, interest rate differentials are just one component of the broader return outlook that dictates the currency allocation decision.

Now that we think growth prospects in the US are diminished, the yield on offer in the US looks less attractive compared to Germany, for example, where you\’re seeing more fiscal spending and yields have gone up as a result, or the UK, where the Bank of England has the highest policy rate among G10 central banks. 

So the yield proposition is more compelling in Europe, relatively speaking, than it has been for some time. 

Additionally, the fact that you saw US bonds sell off when risky assets came under pressure in April means that the hedge characteristics of US bonds are also somewhat eroded relative to bunds in Germany or gilts in the UK.  

Both factors — interest rate differentials and how bonds perform in times of stress — have been shifting in favor of Europe compared to the US. While dollar-denominated US Treasuries will remain a key constituent of global portfolios, what matters for FX is that on the margin these shifts will lead to a more diversified allocation of future investments.  

Do you see the strengthening of the euro and the pound as likely to continue?

We do. Our models suggest that fair value for the euro versus the dollar is somewhere around $1.25, and we\’re still some way away from that. We have a 12-month forecast of $1.20, which would take it closer to fair value, but not all the way.  

In the case of the pound versus the dollar, fair value is around $1.35. We\’re not too far off that mark. But even there, we think on a 12-month basis, the pound will reach somewhere closer to $1.40. 

So in both cases, we expect these moves to endure and extend. We\’ve had very quick moves in a short space of time, and in excess of rate differentials. There\’s always a chance that you have some pullbacks after very quick moves. But I think those pullbacks will provide opportunities for investors who are under-positioned in Europe and the UK to build up their exposures, and those shifts will allow these moves to ultimately extend further.