The EUR/AUD exchange rate does not get the attention lavished on major pairs like EUR/USD or AUD/USD. But for Australian businesses trading with Europe, travellers heading to the continent, or investors with European exposure, it is a rate that quietly matters a great deal. And over the past year, the forces shaping it have been anything but quiet.

Diverging Economies, Diverging Currencies

The broad story of EUR/AUD in recent times has been one of economic divergence. Australia, propelled by strong commodity exports and a resilient labour market, has maintained relatively robust growth. Europe, by contrast, has been battling a succession of headwinds that have weighed on the euro.

Germany — traditionally the engine room of the European economy — has been in or near recession for the better part of two years. Manufacturing output has contracted as energy costs, which spiked following the disruption of Russian gas supplies, remain elevated compared to pre-2022 levels. The German industrial model, built on cheap energy and export-driven manufacturing, is under structural pressure that will not resolve quickly.

France has faced its own challenges, with political instability and fiscal concerns adding to a broader mood of uncertainty. Italy continues to manage an uncomfortably high debt-to-GDP ratio. And the European Central Bank has been caught between the need to support faltering growth and the lingering concern that inflation has not been fully tamed.

Interest Rate Differentials

One of the primary drivers of any currency pair is the interest rate differential, and EUR/AUD is no exception. The RBA has maintained a higher policy rate than the ECB for most of the past year. When Australian rates offer a premium over European rates, capital tends to flow toward Australia, pushing the AUD higher and the euro lower on the cross.

The ECB began cutting rates earlier than the RBA, reflecting the weaker European growth outlook. Each time the ECB has eased while the RBA has held steady, the rate differential has widened, adding downward pressure on EUR/AUD.

But interest rates are not the whole story. Market expectations matter as much as actual rate levels. If traders expect the RBA to cut rates sooner than currently priced, the AUD can weaken against the euro even before any rate change occurs. The forward-looking nature of currency markets means that today’s EUR/AUD rate reflects not just today’s rate differential but the market’s best guess about differentials over the coming months and years.

Trade Flows Between Australia and Europe

Australia’s trade relationship with Europe is significant but often overshadowed by the dominant trade corridor with China. The European Union is Australia’s third-largest trading partner, and the relationship is weighted toward services, processed goods, and investment flows rather than bulk commodities.

Australian wine exports to Europe have been a notable sub-plot. After China imposed tariffs on Australian wine in 2020, European markets became an important alternative. The exchange rate directly affects the competitiveness of Australian wine in European markets — a weaker AUD makes Australian bottles cheaper on European shelves.

On the import side, Australia buys pharmaceuticals, vehicles, machinery, and luxury goods from Europe. A stronger AUD against the euro makes these imports cheaper, benefiting Australian consumers and businesses that rely on European inputs.

Geopolitical Overlay

Europe’s proximity to ongoing geopolitical tensions has been another weight on the euro. The war in Ukraine continues to cast a shadow over European energy security and defence spending. While European governments have increased defence budgets, this spending has come at the cost of fiscal flexibility elsewhere.

Australia, geographically distant from these tensions, has been relatively insulated. The AUD has benefited from a perception of Australia as a stable, resource-rich economy in a volatile world. This “safe commodity” narrative has supported the Australian dollar in periods when European assets are under pressure.

What to Watch Going Forward

Several factors will shape EUR/AUD in the months ahead. The trajectory of ECB rate cuts relative to RBA decisions is the most immediate driver. Any sign that European growth is stabilising — particularly in German manufacturing — could support the euro. Conversely, a further deterioration in European economic data would likely push EUR/AUD lower.

China’s economic performance matters for both sides of the pair but more directly for the AUD. Strong Chinese demand for Australian commodities supports the Australian dollar, while a Chinese slowdown would weigh on it. Europe is also exposed to Chinese demand through its export sector, but the transmission is less direct.

Energy prices remain a wildcard. A spike in global energy costs would hit energy-importing Europe harder than energy-exporting Australia, potentially widening the divergence.

Practical Implications

For Australians with European financial exposure — whether through investment, business, or personal connections — the current environment presents both opportunities and risks. A relatively strong AUD against the euro makes European travel and purchases more affordable. But it also means that European investments, when converted back to AUD, are worth less than they would be with a weaker Australian dollar.

Hedging strategies for EUR/AUD exposure follow the same principles as for any currency pair: forward contracts for known future obligations, regular transfers to smooth volatility, and a clear understanding of how much risk you can tolerate. The pair can be volatile, and the economic narratives driving it can shift quickly.

James Hargreaves is a Sydney-based financial journalist covering currency markets and macroeconomic trends.