As the US economy went into a meltdown during the 2008 global financial crisis, one euro was equivalent to 1.6 dollars. Now, a combination of Europe’s exposure to the front line of the Russia-Ukraine war, and the European Central Bank’s delay in raising interest rates, has brought it closer to parity with the US currency.
The euro plunged below $1.02 for the first time since 2002, during the early years of its emergence as a single European currency.
Why is the euro sinking?
An analysis by Bloomberg Agency indicated that one of the main factors of the current weakness is that Europe suffers the most from the war in Ukraine, which sparked an energy crisis and could lead to a long and deep recession. This puts the European Central Bank in a difficult position, as it tries to curb inflation and ease the economic slowdown, and aims to raise borrowing costs for the first time since 2011. Meanwhile, the US Federal Reserve is raising interest rates faster. This makes the yields on US Treasuries higher than Europe’s debt yields, driving investors to the dollar and away from the euro.
Moreover, according to the analysis, the dollar is benefiting from its safe haven status, which means that as the war continues and the repercussions worsen, the euro will continue to slide.
For years, policymakers have welcomed a weak currency as a way to stimulate economic growth, as it makes the bloc’s exports more competitive. But now, with the rise inflation in the eurozone To its highest levels, currency weakness is undesirable, as it enhances price gains by making imports more expensive.
In June, consumer prices in the Eurozone jumped 8.6% from a year earlier. Some policymakers have highlighted the weakness of the euro as a risk to the ECB’s target of bringing inflation back to 2% over the medium term, even though the ECB is not targeting the exchange rate.
However, when measured against currencies other than the dollar, the euro appears to be more flexible.
1:1 level
Parity is a psychological threshold for the market. The first time the euro fell to parity with the dollar was in December 1999, and it was not even a year since the creation of the European currency.
Just as now, analysts then pointed to a widening spread between German and US bond yields, and stronger growth in the US. This had an effect on the Europeans, who saw in the single currency an important political project and a competitor to the dominant dollar.
Today, the euro is one of the world’s major currencies for transactions and reserves.
Some analysts predicted that the single currency could fall to 90 US cents if Russia escalated the crisis by withholding more gas supplies from Europe. Since the beginning of July, options traders have been placing more bets around the $0.95 level, with $0.9850 likely to be a short-term bottom, according to trading data from the Depository Trust & Clearing Corporation.
According to strategists at Deutsche Bank, a slide to $0.95 – $0.97 will coincide with the maximums seen in exchange rates since the end of 1971 under the so-called “Bretton Woods” system, which pegged the value of many currencies to the US dollar. They said these levels could still be reached in the event of a recession.
Is anyone converting?
The key to changing the euro’s trajectory is to narrow the interest rate differential with other global bond markets. By the time the Fed increased rates by 150 basis points in just three months, the European Central Bank had not yet moved, keeping its key rate negative.
While monetary policy makers in Europe have signaled the start of a tightening cycle, including a possible 50bp increase in September, doubts are growing about its sustainability.
Raising interest rates is more difficult for the European Central Bank than for other central banks. This is because the borrowing costs of highly indebted eurozone countries risk spiraling out of control if investors begin to question the debt sustainability of European countries.
Is the euro in an existential crisis?
The single currency has faced challenges as a concept in the past. Since its formation, naysayers have pointed out the difficulties of managing a monetary union for divergent economies. This became apparent during the Eurozone sovereign debt crisis of 2012, as investors began to shun the assets of highly indebted countries such as Greece, Italy and Spain.
The rise of Eurosceptic politicians in Italy and elsewhere has raised concern about the bloc’s resilience. The defining moment came in July 2012, when then-European Central Bank President Mario Draghi pledged to do “whatever it takes” to save the single currency.
But direct intervention to support the euro in foreign exchange markets is rare, even though central banks took action in the year 2000.