"Column" Oil price shock is looming, but a weak dollar may save Europe

(This article is authored by Mike Dolan, a Reuters columnist, and the following content represents his personal views)

Reuters London, June 19 - If tensions in the Middle East once again impact energy prices, oil-importing countries may find it difficult to escape unscathed. However, as the dollar enters a rare weakening phase, this will significantly lessen the blow to countries outside the United States.

Most crude oil prices are denominated in dollars, so when oil prices rise during a period of a strong dollar, regions like Europe suffer even more.

However, the softening of the dollar this year has had the opposite effect, alleviating the impact of rising oil prices triggered by the war between Israel and Iran.

What is certain is that we are far from the "shock" zone. The global crude oil price in dollars has risen about 14% since the beginning of last week, but it is still well below the January peak and down about 7% from the same period last year.

But due to the euro's 12% rise against the dollar so far this year, the impact of this wave of rising oil prices on Europe has been more moderate.

Chart: Comparison of Brent crude oil prices in euros (blue line), oil prices in dollars (yellow line), and the dollar-to-euro exchange rate (red dashed line) this year.

While dollar-denominated oil prices have nearly erased this year's losses, Brent crude oil prices in euros are still down 12% in 2025, a 20% drop from a year ago.

Tobias Keller, a strategist at UniCredit, wrote on Wednesday: "For oil-importing countries, the decline of the dollar provides a crucial breathing space, helping to mitigate the impact of soaring oil prices and limiting their effect on the overall economy."

If the dollar continues to weaken, it may lessen the relative impact of a new surge in energy prices on the European economy.

This could subsequently support Europe's performance relative to the United States this year and further undermine the narrative of "American exceptionalism" that has stimulated a large flow of investment portfolios into the U.S. in recent years.

Moreover, in the event of another decline in energy prices, a continued weak dollar would only increase the pressure on the European Central Bank to cut interest rates further to prevent inflation from falling significantly below the 2% target.

Increasingly Unstable

The relationship between the dollar and oil prices has become one of the examples of the increasingly unstable financial relationships mentioned by UniCredit strategist Keller this year.

Chart: Comparison of the dollar index and Brent crude oil price trends.

Against the backdrop of the U.S. launching a trade war, readjusting alliances, and disrupting domestic political institutions, foreign investors who have invested trillions of dollars in U.S. stocks and bonds are beginning to reconsider their dollar exposure, leading to changes in the correlation between the dollar and stocks, bonds, and commodities.

Chart: Correlation between the dollar and the S&P 500 index trends.

Most notably, during periods of uncertainty and pressure, the dollar has clearly lost its traditional "safe haven" status, as seen in the turbulent month of April when the dollar fell alongside stocks and bonds.

The correlation between the dollar and oil has become particularly unstable.

Under otherwise similar conditions, a strong dollar should weaken oil prices by suppressing demand outside the U.S., as the cost of oil priced in local currency would increase. Theoretically, the opposite should also hold true However, in recent years, the causal relationship has reversed. After Russia invaded Ukraine in 2022, oil prices soared, stimulating inflation and forcing the Federal Reserve (FED) to raise interest rates significantly. Subsequently, oil prices and inflation declined, and the Federal Reserve entered a period of easing.

In this series of events, the dollar and energy prices fluctuated in sync.

When oil prices doubled from mid-2021 to the invasion of Ukraine, the dollar index (.DXY) surged by 20%, exacerbating the impact of rising energy costs in Europe and other regions. However, after the U.S. elections last year, this relationship broke down again, as the dollar initially rose despite falling oil prices.

Although the positive correlation between the two resumed after January, following the outbreak of war between Israel and Iran this month, oil prices surged without a corresponding strong rise in the dollar. In fact, the dollar remains hovering near recent lows.

Of course, this relationship depends on the context at the time. The main concern now is that as trade, economic, and investment imbalances are forced to correct, the dollar's sustained strength over the past decade is now facing years of adjustment.

If this trend continues, then regardless of how much oil prices soar, the impact on the global economy will not be as severe as last time.

Figure: JP Morgan model shows the estimated impact on inflation rates in various countries for every 10% increase in oil prices