As growth slows in Europe and inflation hits record highs, should we be concerned about the weakness of the euro? Since the start of 2022, the euro has lost nearly 10% of its value against the dollar. If the fall continues, we could reach parity: 1 euro is equal to 1 dollar. This recalls the exchange rates recorded in February 2000 and July 2002.
The war in Ukraine is certainly one of the causes of this fall in the euro: the conflict accelerated the rise in energy and electricity priceswhat fuels inflation. The war has also hampered post-pandemic recovery, and recession threatens. Economist Bruno Colmant, professor at ULB, explains that, “to fight inflation, the European Central Bank (ECB) wanted to increase its interest rates, but unfortunately the most recent confidence indices show that we are entering a recession, which means that the ECB will hardly be able to increase them , at the risk of aggravating this recession”. This has the effect of favoring the dollar against the euro. According to him, “we are going to enter into a combination of inflation and recession: demand will decline but companies will see their competitiveness decline. These elements apprehended by the markets mean that the euro is a somewhat neglected currency compared to the dollar“.
According to Bruno Colmant, another factor is added: the dollar is supported by the American Central Bank (“Fed”, or Federal Reserve): “The United States is almost in a situation of full employment and is almost self-sufficient from an energy point of view. And so, in the United States to combat nascent inflation, one can raise interest rates with some degree of success. The situation in Europe is different because we have inflation and recession, but we are far from having full employment and therefore, even if we increased interest rates, it could not be in the same proportion as in the United States. So, structurally there is a difference in interest rates which is established between the United States and Europe, the American rates being higher than the European rates, this naturally leads to an appreciation of the dollar against the ‘euro“.
What are the consequences of this fall in the euro against the dollar for Belgian businesses and citizens?
According to Bruno Colmant, “For European companies, the fall of the euro against the dollar first has a favorable impact for those who export: a weaker currency allows more exports to areas outside the euro. But on the other hand everything that is imported and denominated in currencies other than the euro increases in value“. This is the case of energy, in particular petroleum products. This has a negative impact for companies, but also for households.
What can the ECB do?
According to him, “the ECB is in an extremely perilous situation. It does not have much time to raise interest rates because it is the first creditor of European states. The latter have sold a large part of their debt to it and any increase in interest rates penalizes the States. Moreover, any rise in interest rates risks aggravating the recession, since the cost of borrowing for businesses and households will increase. If the ECB cannot act, then the real debate about inflation takes place at the level of each of the countries, which should take measures at the national level to combat inflation.“, according to him.
Edward Roosens, chief economist of the FEB (Federation of Belgian Enterprises) adds that the euro weakness adds “a new layer to cost increases for our businesses. On the other hand, it makes our products a little cheaper in dollar markets. But 70% of our exports are made in Europe in euros.“