The figures speak the truth. The political turbulence in Europe is causing forex market mayhem that has rendered the initial Brexit referendum a mere curtain raiser. As GBP/EUR volatility rockets post-2024 EU Parliament elections and currency correlations change radically, traders are struggling to comprehend how these new European political dynamics will forex markets in a way we have not seen since 2016.
Politics in the EU has changed drastically since Brexit, but the effects on the currency markets are only starting to play out. With trade policy uncertainty and the changing monetary policies coupled with the political tensions that are emerging in Europe, we are seeing the perfect storm being brewed in forex volatility as we move through 2025.
The New Political Reality Reforming European Markets
The political ground under Europe is changing. The 2024 EU Parliament elections did not only transform the parliamentary seats; they have essentially transformed the currency markets perception of European stability.
Goldman Sachs believes that 2025 will be especially difficult in the Eurozone, where most of the growth drag will be due to increased trade policy uncertainty, as opposed to the real policy actions. This is a pre-Brexit type of uncertainty, except there is one important difference: the stakes are bigger and the players are different.
The European markets are already increasing trade policy uncertainty measures. The threat of US tariffs is hanging, and even the threat of 25 percent tariffs on steel and aluminum has already made its ripples. The latest remarks by President Ursula von der Leyen reveal the fragile state of transatlantic trade relations, with the president noting that tariffs are taxes that break supply chains and generate economic instability.
Otherwise, the political turmoil is not limited to the trade policy. The diluting of political systems in the Eurozone casts a grave doubt on the diminution of fiscal consolidation capacity. Germany is on the verge of elections and France is experiencing continuous policy uncertainty, which is forming a dual-pressure system that is causing a significant burden on the euro.
The Role of Political Events in Currency Market Mayhem
The currency markets are highly advanced confidence gauges. As political uncertainty increases, capital flows change radically, and this is what causes the volatility patterns we are experiencing today.
The Brexit referendum is the ideal case study. In 2016, when the people of the United Kingdom voted to quit the EU, the pound lost 7 percent of its value against the euro and other key currencies overnight. However, this is what complicates the forex market effects of the current European political changes even more: it is not one and isolated incident, but a variety of different political pressures at the same time.
Currency correlations have been transformed since Brexit. Studies indicate that dramatic changes in the movement of currencies in relation to each other are occasioned by political events. The correlation of such safe-haven currencies as the Swiss franc and Japanese yen increases when there is a political stress, and the correlation between directly affected currencies, such as the pound and euro, with their traditional partners declines.
The transmission patterns of volatility are no less interesting. Political uncertainty is not an isolated problem in individual currencies; it causes spillover effects that are passed across the entire currency networks. Brexit vote resulted in significant declines in volatility transmission between sterling and the euro because of reduced market integration levels.
Stalwart Defiance of Sterling to Recover
Even after the recent gains, the British pound has structural head winds that are unlikely to see it recover fully. The Goldman Sachs Research puts the fair value at about 1.25 pounds to the dollar as against about 1.45 pounds to the dollar prior to the Brexit vote.
The currency debilitation has a certain economic reason. According to Goldman Sachs Kamakshya Trivedi, when you have such a major disruption in the trading arrangements between one of your largest trading partners, which Brexit did involve, then there is going to be an effect on the currency. One of the ways you can adapt to that type of disruption is through currency weakness”.
This assessment can be justified by current data. Four years after Brexit, UK goods exports to the EU are still 18 per cent lower than they were before it. This long term export weakness continues to exert a downward pressure on sterling despite the efforts of the Labour government to seek better relations within the EU.
But there are grounds of hopeful caution. Recently, Goldman Sachs has increased its 12-month sterling target to 1.32, up previously to 1.28, and the sterling to be placed at 1.30 in July 2024 against the dollar. Pound has emerged as the sole G-10 currency performing better than the US dollar in recent times due to better global macro-economic conditions and weakening recession jitters.
The Structural Weaknesses of the Euro
The euro has a more complicated challenge as compared to the sterling. Where Brexit produced a well-defined, definable shock to the pound, the euro is grappling with a variety of, interrelated political and economic pressures that cannot be easily solved.
The most imminent challenge of the euro is interest rate divergence. The European central bank keeps reducing rates and the Federal Reserve is careful about reducing. This discrepancy puts off international investment in euro-denominated assets on a long-standing downward pressure on the currency.
These challenges are compounded by exposure to trade war. Europe is one of the main targets of possible US tariffs and this may make the euro very weak. The effect of the decline in competitiveness and the lack of market access provides a sort of a double bind to European exporters.
The Eurozone has another level of complexity in the form of political uncertainty. Further downside risks on the euro are German elections and policy uncertainty in France. These internal political risks combine with external market forces to bring about increased volatility patterns.
Political Uncertainty Trading Strategies
Intelligent traders are changing their approaches to operate in this new environment of European political risk. Strategies based on volatility have become especially popular, and strategies involving options such as straddles and volatility swaps on USD pairs are becoming more appealing.
EUR/JPY cross presents interesting trading opportunities. Short EUR/JPY positions are a fundamental trade by most institutions given the relative stability of the policy environment in Japan as opposed to the tariff threats in Europe. This is a plan that is taking advantage of the structural weaknesses of the euro and also the safe-haven status of the yen in times of political strains.
The long euro volatility positions are effective against geopolitical shocks. To options traders, the various downside risks facing the euro make volatility purchase a good protection against any unforeseen political eventualities.
Currency hedging is becoming critical to companies with European political exposure. One UK retailer minimized FX losses by 30 percent by dividing payments between EUR and USD where GBP prices fell. This strategy assists in evening out the effects of political turbulence on operating cash flows.
The EU-UK Reset: New Opportunities and Risk
The political crisis results in yet another interesting twist: the potential reset of the EU-UK relationship. The leaders are to convene in an EU-UK Summit in the first half of 2025, which implies that both sides realize that they have to improve cooperation.
The suggested reset comprises a number of important components: strengthened collaboration on the issues of global trade, new legally binding agreements on veterinary standards and emissions trading systems, and improved regulatory cooperation frameworks. Such developments may lower certain structural obstacles that have prevented UK-EU trade to reach the levels before Brexit.
Nevertheless, basic red lines are not crossed. The UK sticks to its stand on the control of immigration and the free movement restrictions whereas the EU keeps demanding the indivisibility of the single market freedoms. These restrictions restrict the extent to which any reset can proceed.
The trade effect of possible deals may be small, yet they can restore mutual confidence and provide significant trade facilitation measures. In the case of currency markets, any positive changes in EU-UK relations would have a positive impact in removing some of the uncertainty that has generally hovered over both the pound and euro.
What Traders Should Pay Attention to in 2025
A number of critical conditions will dictate the evolution of European political changes on forex markets up to 2025. The greatest external risk is the US trade policy, where the possibility of tariffs is causing uncertainty throughout European markets.
Currency movements are still being driven by central bank policy divergence. The ECB cutting cycle also stands in stark contrast to Fed caution, which keeps applied pressure on EUR/USD and other pairs. Traders ought to be on the lookout of ECB communication messages regarding the rate of and the magnitude of reduction in the future.
German and French politics are worth looking at. Both nations experience serious political problems which may impact on the Eurozone stability and euro valuations. Policy announcements and election results of these fundamental EU members are expected to cause instant market responses.
Another important point to monitor is the progress of Brexit implementation. There is a possibility of short term trading opportunities due to the planned EU-UK summit and possible agreements that can be made.
How to Move through the New Political-Currency Landscape
Effects of European political change on the forex market are a paradigm shift in the manner that currency markets are conducted. The present political pressure is not a one-off shock like Brexit: it is long-term, multidimensional, and not easily analyzed or predicted.
To navigate successfully, one must learn that political risk is now a permanent state and not a temporary disturbance. The relationship between currencies has changed and volatility patterns have changed and the old relationships are no longer a good guide.
The beneficiaries will include traders and businesses that will adjust their strategies to this new reality. It implies adopting volatility-related strategies, diversifying currency risks, and being constantly mindful of the political events in various jurisdictions in Europe.
With the year 2025 approaching, it is clear that one thing: the predictability of the European currency markets is dead. Political instability is not a history of the past, but the new normal. The faster the market players learn to accept and adopt this fact, the more they will be able to exploit the opportunities that it creates.
