Morgan Stanley says the euro is nearing its long-standing upside target against the U.S. dollar, with the bank forecasting the EUR/USD pair to reach 1.23 in the second quarter of 2026 as a series of unusual forces continue to weigh on the greenback.
In a note released Friday, the bank’s strategists said EUR/USD has already rallied year to date, driven by unconventional factors that have pushed U.S. dollar risk premia to levels last seen in the second quarter of 2025.
Morgan Stanley reiterated its Q2 2026 target of 1.23, adding that while upside risks remain, it is not yet shifting to a more aggressive bullish scenario. The bank cautioned that medium-term risks surrounding the dollar are still elevated, even though short-term volatility could return if traditional economic data regain market influence.
According to the strategists, the latest phase of dollar weakness cannot be explained by interest rate differentials, which have historically been a key driver of G10 currency moves. Instead, this year’s decline in the dollar has been fueled by atypical catalysts that are difficult to predict and continue to dominate investor focus.
While a stronger euro can support European asset returns when measured in constant currency terms, Morgan Stanley warned it also creates a notable headwind for corporate earnings. The bank estimates that every 5% rise in EUR/USD reduces MSCI Europe’s annual earnings growth by roughly 1.5 to 2 percentage points, largely due to translation effects given the region’s high exposure to overseas revenues.
From a broader macroeconomic perspective, the bank’s economists noted that a 5% appreciation in the euro on a trade-weighted basis could cut euro area exports by around 1.5% and reduce overall economic growth by approximately 0.3 percentage points.
Inflation effects are expected to materialize more quickly, primarily through energy prices. Morgan Stanley estimates that a 10% increase in EUR/USD would lower euro area inflation by about 30 basis points over the next two years.
