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Pound sterling could extend its advance while French debt stress keeps fast money selling the euro.
"The euro slides as European political contagion spreads," says a morning note from French investment bank Natixis. "The trigger is no longer limited to France: Spain is now entering the picture, with reports suggesting that government officials are preparing for an early election, pending a possible statement from Prime Minister Sánchez as early as today."
A Spanish election looks increasingly likely after Sánchez's key housing reforms failed to pass through parliament last week. The news from Spain would not, in isolation, worry markets, but it comes on top of heightened sensitivities over France's debt dynamics.
According to newswire reports, hedge funds were prominent drivers of the selling pressure seen during Asia's trading session, taking the pound-to-euro exchange rate to 1.1802 and the euro-to-dollar rate beneath 1.12.
Last week saw France's ten-year yield spread over Germany reach its widest since 2011.
What makes this episode different from the political crises of recent years is that the euro itself is now moving.
"Concerns about the sustainability of France's public debt are becoming more widespread. They have now started to weigh on the euro as well, which had remained more or less unaffected by the turmoil in bond markets in recent months," says Thu Lan Nguyen, Head of FX and Commodity Research at Commerzbank.
Nguyen identifies the monetary policy channel as the reason, because the euro area's crisis mechanism puts the European Central Bank at its centre.
In a worst case the ECB faces a conflict between its price stability mandate and its financial stability responsibility.
"The fact that the common currency is now coming under pressure suggests, on the one hand, that markets see a rising probability that the ECB may have to intervene after all," says Nguyen.
The second implication is more damaging for the currency.
"Markets appear increasingly concerned that the ECB could ultimately be forced into a more persistently accommodative monetary policy stance in order to ease pressure on long-term bond yields," she adds.
That is the mechanism converting a French fiscal problem into euro weakness: a central bank expected to hold rates down to protect a member state is a central bank that cannot defend its currency.
Above: The French 10-year government bond yield minus German ten-year.
Danske Bank says France remains very much in focus and continues to keep pressure on the euro.
Julius Baer downgraded the euro to bearish against both the dollar and the Swiss franc in its technical work published Monday, and maintains an underweight on European equities.
Rabobank cut its three-month euro-to-dollar forecast to 1.13 from 1.16.
JP Morgan said in a note Friday the euro is still overvalued and vulnerable to furtehr weakness.
Daniella Arcadipane, Senior Currency Specialist at Indigo
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Talk to a specialistDollar strength meanwhile adds to the euro's pressures via the EUR/USD.
US payrolls rose just 29,000 in September against a 90,000 consensus, and markets have priced an October Federal Reserve hike out, leaving this morning's dollar strength without a Fed explanation.
As long as EUR/USD stays under pressure, other euro crosses will struggle to find support.
Sterling has its own support in the gilt market, where ten-year yields now sit only 10 basis points above US Treasuries, the tightest spread since June 2025, according to Julius Baer.
GBP/EUR Now Overbought, Deutsche Bank says Markets Are Too Exciteable
The pound-to-euro rate cleared the 1.1750 resistance that capped it through August and September, and the session high stands at 1.1820.
July's peak at 1.1828 is the next objective, and above it the pair has no structure until 1.1850.
The pace of the rise means the daily RSI rises to 74, (see chart at top) putting it in overbought territory, which argues the pace of this advance will not be sustained even if the direction holds.
A pullback or consolidation becomes possible short-term, although we wouldn't argue in favour of standing in the way of the move.
"The big question is whether this is the start of a new euro sovereign crisis or whether markets have already overshot," says Jim Reid, a strategist at Deutsche Bank. "My bias is towards the latter."
"France’s fiscal problem is real and has been building for years, but that is why the timing of the latest move is so interesting: there has been little genuinely new in the fundamentals," he explains.
Where the Euro Case Could Turn
The limit on euro weakness is the German bond market.
"As long as investors have access to a euro-denominated safe asset, the current problems of the French government remain a problem for OATs rather than for the euro itself," says Nguyen.
Commerzbank saw the first signs of contagion from France to other EMU countries late last week, though Bunds have so far stayed clear of it.
"Early signs of contagion spilling over to Germany would therefore constitute a clear warning signal for the euro," says Nguyen.
Until that happens, Commerzbank expects the euro's depreciation potential to stay limited.
The growth data supports that caution, with Danske's EuroCOIN indicator pointing to eurozone growth near 0.4% in the third quarter, consistent with September's PMIs and the Ifo survey.
Friday also ended better than it traded: the French spread widened 20 basis points intraday before closing unchanged, according to SEB, with European yields down just over 5bp on the day.
Isabel Schnabel speaks on Monday and the ECB minutes follow on Thursday, and any sign that the Governing Council is weighing the yield response rather than the inflation data would confirm the fear now driving the selling and open 1.1828.
Daniella Arcadipane, Senior Currency Specialist at Indigo
Moving a life-changing sum abroad? You won’t be doing it alone.
One specialist explains every step in plain English and stays with it until the money lands. FCA authorised, FRN 594433.
Talk to a specialist
