EUR/USD is currently trading not far from its lowest level of the year, with its direction being driven by a global energy shock and rising political risks in Europe.

In August, EUR/USD came close to 1.20, but it has fallen about 2% this month to a two-month low slightly below 1.14. The pair is now trading at around 1.137.

A Federal Reserve rate hike restored its inflation-fighting credibility and boosted the dollar. At the same time, the euro's outlook has also been clouded by political factors and another rise in oil prices, which could hurt an economy that had previously performed better than expected.

"How long can this growth resilience last? Can it really make it through the whole winter? Then we enter spring, and we may run into some tricky political situations," said Jane Foley, senior FX strategist at Rabobank.

German Chancellor Friedrich Merz is under pressure from the far right's gains in recent state elections, an unexpected result that may force him to downplay his previously promised reform agenda. Meanwhile, French markets are under pressure from high-debt concerns and political gridlock ahead of the 2027 presidential election.

"In this environment, I am a little concerned about the euro," Foley said, adding that she is reassessing her forecast for EUR/USD at 1.16 in three months.

The premium investors demand to hold French 10-year government bonds over AAA-rated German bunds has risen above 110 basis points, a warning signal for the euro. Bank of America FX strategists estimate that for every additional 10 basis points of spread widening, EUR/USD falls by 0.4%.

Options traders are also becoming more negative on the euro. The three-month euro risk reversal, which reflects the difference between the price of buying and selling options on the currency, last week recorded its largest weekly drop since the outbreak of the Iran war.

European Natural Gas Prices Need to Fall

Analysts and investors say euro bulls still have reasons not to lose heart, because traders are currently pricing in at least one more European Central Bank rate hike this year and the economy has also shown resilience. But almost no one denies that high energy prices have clouded the currency's near-term outlook.

EUR/USD rose about 13% last year, but the Iran war has hurt the euro this year. The conflict disrupted liquefied natural gas shipments through the Strait of Hormuz, pushing gas prices this month above 80 euros per megawatt-hour, the highest since late 2022.

Analysts say European natural gas prices need to soften for the euro to resume its rally, but that is unlikely in the near term.

"If you look at the forecasts from commodity forecasting agencies, most predict European natural gas prices in the 85 to 100 range," said Kaspar Hense, senior portfolio manager at RBC BlueBay Asset Management.

"If that happens, then the euro (against the dollar) could easily fall to 1.12," Hense added.

Meanwhile, discussions about a possible U.S. ban on diesel exports would exacerbate the problems facing the euro, though analysts say this is not their base-case scenario.

ING FX strategist Francesco Pesole said a jump in oil prices toward $115 per barrel would add pressure, because such a level would intensify concerns about economic growth.

"But if central banks maintain a hawkish stance, the euro should not depreciate significantly," he said, adding that ING is maintaining its forecast for EUR/USD at 1.16 by year-end.