Interest rates and exchange rates are closely linked. When interest rates rise, a currency typically strengthens. When rates fall, the currency may weaken.
For the euro, this relationship is largely shaped by the decisions of the European Central Bank (ECB). But, like any currency, the euro is also affected by a wide range of economic and geopolitical factors.
In this article, we’ll explore what interest rates are, why they affect the euro, how ECB decisions have impacted the currency in the past, and what might be next for the euro in 2025.
Table of contents
- What are interest rates?
- How do interest rate changes affect the euro?
- How have interest rate changes affected the euro in the past?
- What happened to the euro in 2024?
- What could happen to the euro in 2025?
- Conclusion
- 10 FAQs about how interest rates affect the euro
What are interest rates?
Interest rates are a key economic tool used by central banks to control inflation and support economic growth.
In the Eurozone, the ECB sets the main refinancing operations (MRO) rate. This is the rate at which commercial banks borrow money from the ECB and impacts interest rates across the region.
When inflation is high, the ECB raises interest rates to slow down spending and bring inflation under control. When the economy needs support, the ECB lowers rates to encourage borrowing, investment, and growth.
Read: How does inflation affect exchange rates
How do interest rate changes affect the euro?
Rising interest rates in the Eurozone tend to boost the value of the euro. This is because higher rates attract foreign investors seeking better returns on their capital.
Foreign investment flows into the Eurozone increase demand for the euro, which pushes up its exchange rate.
When rates are cut, the opposite effect can occur. Investors may pull money out of the euro area in search of higher yields elsewhere, weakening the euro.
However, other factors can influence whether a rate decision strengthens or weakens the euro, including:
Market expectations
If a rate hike or cut is already priced in, it may have little impact on the euro.
Economic strength
If rate hikes are seen as damaging to growth, the euro might weaken despite higher rates.
Global events
Geopolitical risks or global downturns can drive risk-off sentiment, benefiting safe-haven currencies like the USD while weighing on the euro.
How have interest rate changes affected the euro in the past?
Over the last two decades, the ECB has moved rates in response to inflationary pressures, financial crises, and economic growth trends.
Eurozone debt crisis (2011-2012)
In 2011, the ECB raised rates in response to inflation. But with the Eurozone debt crisis unfolding, the move was widely criticised. Shortly after, the ECB reversed course and cut rates aggressively in 2012. The euro weakened as investor confidence in the Eurozone faltered.
COVID-19 pandemic (2020)
The ECB slashed rates and launched massive stimulus measures to support the Eurozone economy. The euro saw mixed performance but gained strength in the second half of 2020, driven by global risk appetite and a weaker US dollar.
Read: What is a black swan event?
Post-pandemic inflation (2022-2023)
In response to soaring inflation, the ECB ended years of low rates with sharp hikes. Between July 2022 and September 2023, the ECB increased interest rates by 450 basis points from 0% to 4.5%.
The euro initially strengthened against currencies such as the pound sterling, but concerns over slowing Eurozone growth later dampened the euro’s performance.
What happened to the euro in 2024?
2024 was a complex year for the euro. Inflation in the Eurozone steadily declined, encouraging the ECB to slow its aggressive interest rate hikes.
ECB cuts rates in late 2024
In October and December 2024, the ECB cut rates by 25-basis-points, bringing the main rate down to 3.15%.
While markets anticipated the first cuts for almost a decade, the original decision still saw EUR/USD drop 0.6% on the day, with the second causing a further 0.9% dip.
Investors reacted to signs of slowing German and French growth and growing speculation that the ECB may ease further in 2025.
Despite this, the euro recovered modestly in December as the US Federal Reserve signalled its own rate cuts for 2025, narrowing the gap between the dollar and euro.
What could happen to the euro in 2025?
As of March 2025, the euro faces a mix of risks and opportunities.
With inflation now hovering close to the ECB’s 2% target, further rate cuts could be on the horizon. If the ECB continues to ease while the Fed holds steady or delays cuts, the euro could weaken against the dollar.
However, a lot depends on broader sentiment and economic data. If the Eurozone economy avoids recession and global risk appetite grows, the euro may hold firm or strengthen.
Another key risk is geopolitical tension. Ongoing war in Ukraine and instability in the Middle East continue to weigh on investor sentiment. Traditionally, the euro has weakened during times of uncertainty. However, it’s performance in recent years during geopolitical uncertainty has shown some optimism, making it a difficult one to call.
Read: Why is inflation rising in the UK?
Conclusion
Interest rates play a critical role in the value of the euro, but they’re not the only factor.
While rate hikes tend to lift the euro and rate cuts often drag it down, other forces – like market expectations, global risks, and Eurozone economic performance – also play a major role.
With more ECB meetings ahead in 2025, and global uncertainty still in the air, it’s vital businesses plan for a range of scenarios for the euro.
At Privalgo, we help businesses build FX solutions using tools like forward contracts and market orders. This helps protect costs and maximise opportunities in volatile markets.
Want to learn more? Fill out the form below to speak to one of our Currency Specialists.
10 FAQs about how interest rates affect the euro
Below are 10 frequently asked questions about the euro and interest rates. Some answers use content already discussed in this article.
What happens to the euro when interest rates rise?
Typically, the euro strengthens as higher interest rates attract foreign investment, boosting demand for the currency. However, other factors can play a role meaning this relationship isn’t always certain.
Why do interest rates affect exchange rates?
They influence capital flows. Higher rates offer better returns, attracting investment and increasing demand for the currency.
What is the current ECB interest rate in 2025?
The ECB sets three interest rates for the Eurozone. As of 18th March 2025, the ECB’s main refinancing rate is 2.65%, following two cuts in Q4 2024. Its deposit facility rate is 2.50% and the marginal lending facility rate is 2.90%
Will the ECB cut rates again in 2025?
With inflation is nearing target, and recent data suggesting slower growth in major Eurozone economies, it’s likely. That being said, a massive variety of factors can influence the ECB’s decision – so we’ll have to wait and see.
How do interest rate decisions impact businesses?
They affect borrowing costs, currency value, and import/export prices – all crucial for international businesses.
What happened to the euro after COVID-19?
After mixed performance early in the pandemic, the euro strengthened in late 2020 amid global recovery optimism and US dollar weakness.
What role does inflation play in ECB rate decisions?
A major one. The ECB raises rates to slow inflation and lowers them to encourage growth when inflation is low.
How does the euro compare to the US dollar in 2025?
From the beginning of 2025 to the time of writing (18th March 2025), the euro has gradually strengthened against the dollar. After trading at 1.025% on 1st January, the rate now sits at 1.091.
Markets will keep a keen eye on interest rate decisions and other significant economic factors like Trump’s tariffs as the year progresses.
Does the ECB meet regularly to set interest rates?
Yes, the ECB holds policy meetings every six weeks to review and adjust rates based on economic conditions.
How can businesses protect themselves from euro volatility?
By working with currency specialists like Privalgo, businesses can bring more confidence to their euro costs in the face of uncertainty with efficient currency management.
This article is for information purposes only and should not be regarded as financial advice.
