The latest decline came after US inflation accelerated more than forecast in June.
The euro has undergone a rapid and brutal slump this year and has now crossed an important threshold for the first time in more than two decades: parity with the dollar.
The 12% drop is the result of multiple pressures, from the war in Ukraine to an energy crisis and the growing risk of Russia cutting off gas exports and pushing the eurozone into recession. Add to that central banks moving at vastly different speeds and a much-demanded dollar, and some analysts say parity may not be the end point, but just a stepping stone to further weakness.
The common currency fell as much as 0.4% on Wednesday, reaching as low as $0.9998. The latest leg decline came after US inflation accelerated more than forecast in June, boosting Federal Reserve bets on rate hikes. It bounced back to trading at around $1,002 as of 2:10pm in London.
The downward spiral was not accompanied by the kind of existential doubts that hung over the euro when it collapsed in the early 2000s, or when the sovereign debt crisis erupted a decade ago. However, it is still a problem for the European Central Bank.
It is also a problem for consumers in the 12 trillion euro economy, which is fueling an inflation spike that is already spiraling out of control, with prices rising at a record pace of almost 9%.
The depreciation has been incredibly fast as the euro traded close to $1.15 in February. It is all the more remarkable given that less than two years ago, ECB policymakers were concerned about an excessive strength of the euro leading to under-inflation. Now they face another world: a dramatic plunge in their currency and rising consumer prices.
Some ECB policymakers have already indicated that they are thinking of the weakness, especially when it comes to imported inflation. Earlier Wednesday, Francois Villeroy de Galhau said the central bank is monitoring the euro’s decline due to its effect on consumer prices.
In addition to the double threat of inflationary recession, the ECB also faces the risk that the cost of government bonds will diverge too much as it reverses the course of the stimulus. After Italian interest rates peaked last month, the Frankfurt-based institution began work on a tool to prevent the outbreak of another debt crisis in the region.
The euro’s decline this year is only part of a global story of dollar dominance. The greenback has favored this year as a haven investment, helped by higher US interest rates, and there has been speculation that the rally could spur global policymakers to step in to weaken it at some point.
At a meeting in Tokyo on Tuesday, US Treasury Secretary Janet Yellen and Japanese Treasury Secretary Shunichi Suzuki said volatile exchange rates pose a risk, promising to consult and “cooperate as appropriate on currency issues”. The yen has fallen to its lowest point against the dollar since 1998.
The single currency, meanwhile, has suffered mainly from Europe’s proximity to the war in Ukraine and its dependence on energy imports from Russia.
Monetary policy is also a driving force, as the ECB has been slow to adopt the kind of aggressive policy tightening being deployed elsewhere. At the same time, increasing Federal Reserve rate hikes have pushed the dollar up and created a rate differential that will keep pressure on the common currency.
Nomura International Plc strategist Jordan Rochester is already targeting further pain with a drop to 95 cents. Citigroup sees it falling below that level if Russia cuts its gas exports to Europe. The euro “will remain virtually unsaleable this summer,” Société Generale SA’s Kit Juckes said earlier this month.
The euro, now the currency for 19 countries and about 340 million people, has seen many ups and downs since its inception in 1999. viability and even bleak predictions of his demise.
At the time, the first president of the ECB, Wim Duisenberg, said the exchange rate is “not a target”. That’s a refrain repeated by policymakers during subsequent periods of weakness or volatility.
Still, that didn’t stop the central bank, along with the US, UK and others, from making a surprise intervention to boost the euro in 2000.
Shortly after Russia invaded Ukraine, we predicted that the euro would fall on parity. The war is a blow to the eurozone. It undermines Germany’s economic model, which for decades was built on cheap Russian energy. Without German growth, the eurozone is in real trouble… pic.twitter.com/xwdwVig5qq
— Robin Brooks (@RobinBrooksIIF) July 8, 2022
The euro’s initial slump gave way to a period of appreciation, with the currency reaching $1.60 at one point in 2008. That force was seen as damaging to the economy, and eurozone politicians blamed it for hurting businesses. Among those voices was the then French finance minister, Christine Lagarde.
The euro weakened again when the global financial crisis broke out in 2008, then entered a period of volatility as the European sovereign debt crisis wreaked havoc. Again, the euro’s future was in doubt amid rising borrowing costs, bailouts for indebted countries, a recession and record unemployment. It was at that time that then-ECB president Mario Draghi compared the euro to a bumblebee — a ‘mystery of nature’ that shouldn’t be able to fly, but it can.
When the worst of that period was over, the ECB continued its stimulus measures, limiting the currency’s upward momentum. Thereafter, from mid-2021, the euro started a steady downward move towards parity.
While the ECB could raise more aggressively to boost the euro now — a line of reasoning Governing Council member Robert Holzmann has used to justify a half-point hike — its agency could be limited by the murky economic outlook. In a Bloomberg survey this month, economists estimate the risk of a recession in the eurozone at 45%, up from 30% in June.
“The ECB will no doubt be very concerned about the move, especially if it evolves into a ‘sell the eurozone’ mentality,” said ING Groep NV strategists led by Chris Turner. “Yet faced with the looming risk of a recession – and the euro is a pro-cyclical currency – the ECB may be tied down in its ability to threaten more aggressive rate hikes in defense of the euro.”
