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The fall of the euro towards parity with the dollar reflects a greater blow from the war in Ukraine

By on July 13, 2022 0

On Tuesday, Croatia cleared the final hurdle to achieving its long-held ambition to become the single currency’s 20th member – a move central bank chief Boris Vujčić said would bring “more security” and “ would increase the standard of living of our citizens”.

But while Zagreb wants in, the currency markets want out.

The euro is now worth a fraction above a single dollar for the first time since 2002, rekindling memories of its difficult early years when it fell so low that traders dubbed it the ” toilet money” and that major central banks have launched a concerted intervention to instill faith in the project.

Constituting a fifth of global foreign exchange reserves and a quarter of global bond issues, the euro is no longer seen as a business doomed to failure. However, the parity with the dollar highlights the growing gap between the economic prospects of the United States and the euro zone, which is more exposed to the fallout from the war in Ukraine. The weakness of the euro, which will increase the price of imports, will worry policymakers already struggling with record inflation.

“There is a feeling that the euro zone economy will simply not be robust enough to be part of the global slowdown,” said Alan Ruskin, chief international strategist at Deutsche Bank.

The rapid fall in the euro, from $1.19 last year to $1.0057 on Tuesday night, comes as Russia fears it will cut off its already tight supply of natural gas to Europe, forcing energy to being rationed and triggering a painful recession in the region.

“We continued to buy dollars when we started to worry that the global economic landing might be harder, not softer,” said Kit Juckes, currency strategist at French bank Societe Generale. “The other main currency of the world [the euro] is massively handicapped by the fact that its energy crisis is potentially of an entirely different magnitude.

The greenback has soared against most currencies – not just the euro – following a series of rate hikes by the Federal Reserve, culminating in a 75 basis point increase last month. which brought the target range between 1.5% and 1.75%. “Monetary policy in the United States continues to stimulate the euro more at this stage than the European Central Bank,” said Dirk Schumacher, head of macro research Europe at Natixis. “The Fed is the main driver of the euro.”

The euro has fared better on a trade-weighted basis, where it is measured against a basket of 42 currencies – down just 1.6% year-to-date, compared to 11% a year earlier. against the dollar.

The ECB has yet to raise rates from their all-time low of minus 0.5%, but is expected to do so next week with a modest quarter-point hike. A series of increases by the Bank of England failed to shield the pound from greenback strength. “The pound has also depreciated by 11% against the dollar since the end of last year,” said Vítor Constâncio, former vice-president of the ECB.

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Robin Brooks, chief economist at the Institute for International Finance, a banking trade group, said currency traders were betting a severe downturn later this year would prevent the ECB from raising rates well above zero. “The cumulative damage to the eurozone is already significant,” said Brooks, a former currency specialist at Goldman Sachs. “Forex markets lead the rest of the trading complex on this.”

Underscoring the gloom, think tank ZEW’s monthly gauge of investor expectations for the German economy fell to its lowest level since the start of the eurozone sovereign debt crisis in 2011 in June.

The impact of the strong dollar is particularly significant at a time when the cost of energy, which is priced in dollars on international markets, is skyrocketing. Deutsche Bank has estimated that the euro zone will suffer a negative 400 billion euro hit to its trade balance this year if prices remain at current high levels.

The weaker single currency is also boosting inflation, pushing up the price of imports and contributing to a record 8.6% rise in consumer prices in the year to June.

For every 10% depreciation of the euro against the dollar, an additional 0.2 percentage point is added to eurozone inflation next year, Schumacher estimated. “It’s not a game changer, but every little bit counts and I’m sure it would be welcome at the ECB if the euro rebounds,” he added.

While the fall of the euro against the dollar mainly reflects cyclical changes in the global economy and not structural changes, some economists fear that the energy crisis will have a lasting impact on Europe’s competitiveness. Maria Demertzis, deputy director of Brussels-based think tank Bruegel, said: “If the change in the energy mix the EU is facing alters its competitiveness, it could mean the euro is starting to fall, and that’s something to watch. “

Before inflation hit 40-year highs in much of Europe and North America, a weaker currency was seen as an economic advantage.

Just three years ago, former US President Donald Trump accused the ECB of “unfairly” manipulating the euro lower to boost exporters in the region by making dovish comments on policy. With prices soaring, this is no longer the case. “It’s not at all clear that the United States is particularly unhappy with the level of the dollar,” said Francesca Fornasari, head of currency solutions at Insight Investment.

Croatia will join the single currency early next year.