The euro (EUR) has remained in a narrow range against the U.S. dollar (USD) for most of 2023, and UBS analysts predict that this trend could continue throughout 2024.

According to UBS, a combination of political, economic and market dynamics make forecasting the exchange rate particularly arduous. Key factors influencing this outlook include the French election results, UK economic policies under a novel administration and upcoming US economic data releases.

The impact of the French elections

The recent French elections had a significant impact on the EUR/USD outlook. The election resulted in a hung parliament, and President Emmanuel Macron’s centrist Ensemble group performed better than expected.

The far-right National Rally (RN) party suffered a massive defeat, finishing third behind the left-wing New Ecological and Social Union (NUPES) coalition and Macron’s centrists.

UBS analysts noted that the election results remove the direct risk of conflict between the next French government and the European Union. After the rejection of the radical proposals of the RN, the probability of EUR volatility caused by French political uncertainty decreased.

However, the composition of the novel government and its policy directions remain unclear, which could have an impact on the euro in the medium term.

Despite the election results being less turbulent than feared, UBS maintains its long-term target for EUR/USD at 1.0500. Analysts say that while the French political results are not a worst-case scenario, they are not particularly positive for the euro either.

Macron’s focus on domestic politics could limit his ability to further drive EU integration, which could have an impact on the euro.

EUR/USD decline scenarios

UBS presents three scenarios that could lead to a bigger decline in the EUR/USD pair than currently forecast.

In the first case, UBS said that if the novel left-wing French government actively works to reverse key reforms such as raising the retirement age, it could create uncertainty in the market and put pressure on the euro.

Second, the deadlock in the French government could create a sense of instability that would negatively impact investor confidence and the value of the euro.

Finally, upcoming French economic data, including flash PMI, business and consumer confidence, could show signs of weakness due to political uncertainty. Weak economic performance would make it harder for France to meet its budget targets, which would weigh on the euro, UBS said.

Despite the challenges, UBS maintains its EUR/USD target at 1.0500, with possible deviations depending on future political and economic events.

Meanwhile, a potential change in the Democratic Party’s lineup is likely to fuel tensions in markets, which could lead to increased volatility.

However, with no specific date or timeline for changes beyond the Democratic National Convention on August 19-22, pricing the risk premium associated with this issue remains arduous.

UBS analysts believe the upcoming election will be a catalyst for increased implied and realized volatility in the second half of the year.