By Sophie Kiderlin and Dhara Ranasinghe
LONDON, Sept 29 (Reuters) - The fortunes of the euro, trading not far off its lowest levels of the year against the dollar, are in the grip of a global energy shock and growing political risk in Europe.
The euro was heading towards $1.20 in August, but has fallen around 2% this month to two-month lows of just below $1.14.
While a US rate rise that has restored the Fed's inflation-fighting credentials has bolstered the dollar, the euro's outlook has also been muddied
by politics and a renewed rise in oil prices that could hurt an economy that has held up better than expected.
"How long can this growth resilience last? Can it really last through the winter? And then we go into the spring, and we might have some messy politics," said Rabobank senior currency strategist Jane Foley.
Chancellor Friedrich Merz is reeling from the success of Germany's far right in recent state elections, a shock that could force him to water down his promised reform agenda, while French markets are under pressure from worries about high debt and political gridlock ahead of a 2027 presidential election.
"I am a little bit worried about the euro in that environment," said Foley, adding that her forecast for euro/dollar at $1.16 in three months is under review.
The premium investors demand to hold French 10-year government bonds over triple-A rated Germany has shot above 110 basis points, a warning sign for the euro.
Every further 10 bps widening would be associated with a 0.4% fall in euro/dollar, BofA FX strategists estimate.
The single currency was last trading at around $1.137.
Options traders are also turning more negative on the euro.
Three-month risk reversals for the euro, which reflect the difference in the price of options to buy the currency and the price of those to sell it, last week posted their biggest weekly fall since the start of the Iran war.
EUROPEAN GAS PRICES NEED TO FALL
While analysts and investors say there are reasons for euro bulls not to lose heart, with traders pricing in at least one more euro zone rate hike this year and the economy proving resilient, few deny the near-term outlook for the currency has been muddied by high energy prices.
The euro surged some 13% against the dollar last year but the Iran war has hurt the currency this year.
The conflict has choked liquefied natural gas shipments through the Strait of Hormuz, sending gas prices above €80 per megawatt hour this month, the highest since late 2022.
European gas prices need to soften for the euro to resume its ascent, but that is not on the near horizon, analysts said.
"If you look at commodity forecasters, most of them predict the gas price for Europe in the 85 to 100 range," said Kaspar Hense, senior portfolio manager at RBC BlueBay Asset Management.
"If that were to happen, then we (the euro) could easily go to $1.12," Hense added.
Meanwhile, talk of a possible US ban on diesel exports would fuel the euro's problems, although analysts said that was not their main case scenario.
ING currency strategist Francesco Pesole said a jump in oil towards $115 would add pressure as such levels would heighten growth worries.
"But if central banks stay hawkish there should not be a sharp depreciation of the euro," he said, adding that ING was maintaining its $1.16 year-end forecast for euro/dollar.
(Reporting by Dhara Ranasinghe and Sophie Kiderlin; Editing by Elisa Martinuzzi and Alexander Smith)
