The natural rate gap continues to drag the euro down – Societe Generale

The neutral (or natural) rate of interest is both one of the more fashionable and most frustrating ideas in central bank watching. The real rate of interest that keeps supply and demand of both consumer and capital goods in some kind of equilibrium is a lovely concept with a few problems1) it’s a real rate and requires an underlying assumption about inflation. 2) the real rate itself is hard to estimate and changes over time and 3) we live in an open global economy (for now) and different countries have different neutral/natural rates, Societe Generale’s FX analyst Kit Juckes notes.

EUR/USD to trade at 1.12 in the end of 2025

“Ignoring the challenges posed by a neutral rate economists struggle to estimate with any confidence and which changes over time, international variability has implications, of which two are shown in the charts below. The first plots the Eurozone-US differential against EUR/USD. The second plots the relative neutral rate against the US-EU net international investment position. The conclusion is intuitive: Higher neutral rates cause persistent capital flows into the US and pushing the dollar higher. And since changes in neutral rates reflect long-term changes in economies, this isn’t a short-term phenomenon.”

“As long as this lasts, EUR/USD will make a series of lower highs and lower lows, getting further away from PPP (1.27. last seen briefly in 2020). Because the terms of trade and economic shock from the full-scale invasion of Ukraine in 2022 was so big, we’ve guessed that the 2022 EUR/USD low will last for a fair length of time and we have been forecasting that EUR/USD will rebound to somewhere in a 1.10-1.20 range, determined by the US rate cycle.”

“It's possible that the US neutral rate is even higher, implying that the Fed easing cycle is almost over and EUR/USD fair value range is even lower than we are assuming but for now, we’re going to resist jumping on that bandwagon. Our latest forecast reflects this but lowers the end-2025 forecast to 1.12.”