The euro’s path to reserve status

The United States dollar’s loss could be the euro’s gain.

Since its introduction in 1999, the euro has steadily gained recognition as a potential reserve currency. In 2025, diminishing confidence in the $US has enhanced the euro's appeal, amid fading US economic exceptionalism, fiscal sustainability concerns and global trade uncertainty.

Additionally, an improving euro-area growth outlook relative to the US and Germany's fiscal pivot has bolstered the credibility of the Eurozone, supporting the appreciation of the euro.

As global trade continues to find its new shape, developments in European fiscal policy and a rise in hedging flows may lay the groundwork for future euro adoption.

The euro’s outsized outperformance in 2025 has been mostly against the $US and less so against other currencies. This has likely been driven by a reallocation of portfolio flows rather than reserve accumulation.

The euro's share in the International Monetary Fund (IMF) reserves is significant but still trails behind the $US dollar. As of the fourth quarter of 2024, the euro accounted for about 20 per cent of the allocated reserves, while the $US dollar held a dominant share of 58 per cent.

Despite the euro's substantial presence, the $US remains the primary reserve currency globally. But the market is changing.

Limitations

The euro’s journey towards achieving reserve currency status is held back by structural limitations, cautious European Central Bank (ECB) policies, and fragmented market dynamics.

One of the key structural impediments to the euro's path is the lack of a unified fiscal authority across the euro area. While the ECB manages monetary policy, fiscal policy remains the domain of individual member states.

Furthermore, a single interest rate across the eurozone can result in it being excessively restrictive for some economies and lenient for others at the same time. This imbalance can lead to uneven economic growth and stability within the region. For example, inflation is over 4 per cent in Hungary and Poland, but 2 per cent or below in Germany and France.

The disparity in debt dynamics also undermines the euro's credibility as a consistent and unified reserve asset.

Germany has a 62 per cent debt-to-GDP (gross domestic product) ratio. Spain’s at 104 per cent and Italy’s is at 138 per cent, giving those nations limited capacity to stimulate their economies during downturns. This detracts from the euro's potential to serve as a reserve currency.

Unlike the US Treasury market, which offers deep liquidity and a unified risk-free benchmark, euro-denominated sovereign debt is fragmented across multiple issuers, and includes varying credit risks.

For example, German government bonds yield under 3 per cent, Italian bonds above 3 per cent and Polish bonds above 5 per cent. This fragmentation limits the euro's safe-asset pool, a critical requirement for reserve managers, and increases complexity, and therefore risk, for foreign central banks seeking to diversify reserves.

While the euro is widely used in trade within Europe, its global role remains secondary to the US dollar. The latter makes up 49 per cent of total global payments, compared to the euro’s 20 per cent, due to the US's open capital account and deep financial markets. The euro's share in global reserves has diminished from its peak of 28 per cent in 2010 to 20 per cent of total IMF reserves.

While Germany’s recent €850 billion defence and infrastructure initiative is determined by its government, the plan may conflict with European Union (EU) fiscal regulations unless specific exemptions are secured. This underscores the delicate balance between national interests and wider European Commission requirements.

Fragmentation

The fragmentation of euro-denominated sovereign debt, shallow capital markets and geopolitical vulnerabilities obscures the euro’s potential as a reserve currency. However, Germany’s evolving fiscal stance, such as increasing issuance of euro-denominated assets, could enhance the euro’s reserve appeal.

But this will also come with an improvement in the German growth outlook, possibly with positive spillovers to the eurozone and, more importantly, an increased issuance of euro denominated debt in the form of German bunds.

This likely will, to some extent, reduce the shortage of euro reserve-asset supply, better aligning with efforts to deepen European capital markets and improve euro liquidity. ECB President Christine Lagarde has recently called the euro rally a “global euro moment”.

Any journey towards achieving reserve currency status for the euro will be slow and deeply structural, requiring years (if not decades) of progress and resolution of these challenges. But we may just be watching the first steps.

Mahjabeen Zaman is Head of FX Research at ANZ