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The euro to less than a dollar, the fall which “worries” against a backdrop of the energy crisis

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The euro to less than a dollar, the fall which “worries” against a backdrop of the energy crisis
Written by madishthestylebar

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One euro was equivalent to less than a dollar on Wednesday, a threshold that had never been reached since the introduction of the single European currency twenty years ago. While investors bet on the greenback, the market fears a major energy crisis in Europe, a consequence of strained relations with Russia.

For a few hours on Wednesday July 13, the euro traded at less than a dollar – a first since the euro was introduced in January 2002. For twenty years, the single European currency has maintained its above the greenback, with a peak at more than 1.60 dollars in July 2008, when the American currency had lost its value due to the subprime crisis.

The situation has now changed: the euro has not exceeded 1.20 dollars for a year, according to data from the European Central Bank. Worse, it has continued to lose value for a year despite fluctuations, until it reached this symbolic threshold on Wednesday.

  • What led to this virtual euro-dollar parity?

This can be explained firstly by the growth forecasts which do not encourage optimism in the euro zone. In May, the European Commission revised its forecasts for European GDP downwards: it projects growth of 2.7% in 2022, against 4% initially forecast. “There is an economic slowdown, a risk of recession in the euro zone, and with less growth the value of the euro tends to fall,” said economist Marc Touati, also president of the consulting firm Acdefi.

The differing reaction of the eurozone and the United States to rising inflation also contributed to the European single currency losing momentum. The US Federal Reserve (the Fed) has raised its key rates several times since March, reaching a level not seen since 1994, to limit inflation to 2% (against 9.1% over a year now). The European Central Bank certainly made the same choice but later, in June, when inflation reached 8.1% in the euro zone in May.

The geographical proximity to the war in Ukraine played a major role in the devaluation of the euro against the dollar. “The euro zone finds itself at the forefront and is directly impacted by the conflict from an energy point of view, which has a negative impact on its trade balance”, explains Rémi Bourgeot, economist and associate researcher at Iris. Faced with the heavy dependence of many European economies on Russian hydrocarbons, the dollar has on the contrary done well and gained almost 14% in value since the start of the year.

A last reason, and not the least, has a negative impact on the single European currency: “The euro zone is undergoing a crisis of confidence”, explains Marc Touati. “Indeed, it only makes sense if it is an ‘optimal monetary zone’, that is to say a particularly budgetary homogeneity (a path from which it seems to be moving away in recent months, editor’s note)”. The current situation is creating dissension between European states, particularly on the issue of public debt, which several states, including France, have increased more than others during the Covid-19 health crisis.

  • What are the consequences for the European economy?

One of the first consequences is immediate: European goods sold abroad (exports) will display a more competitive price, while conversely, companies in the euro zone which buy abroad (imports) will see their costs increase. Several sectors are favored by this effect in the euro zone: the manufacturing industry, luxury and aeronautics companies… But this will also benefit American tourists, who should have more purchasing power if they come to spend their holidays in the euro zone this summer.

These few positive exceptions present “a very limited advantage” for Marc Touati. The economist explains that the current weakness of the euro will generally be rather “a major inconvenience”: “This drop in the euro will add fuel to the fire, since it will increase the price of products imports and therefore fuel inflation – which is already very high.”

The other negative consequence of a weak euro will also be felt on the price of raw materials such as oil or gas, paid in dollars on the international markets. We can then expect an increase in the energy bill, in particular for European companies that are highly dependent on these energies. The impact of the fall in the euro could, for example, impact the finances of airlines – of which almost a third (24%) of annual expenditure should be allocated to the purchase of fuel for their planes.

“With this energy crisis and with world markets where prices are soaring, the fall in the euro will have the effect of leading to an increase in the price of raw materials and this will further fuel the inflationary dynamic”, specifies Rémi Bourgeot.

  • What are the medium-term prospects?

One of the main levers available to the euro zone to limit the decline of its single currency lies in the hands of the European Central Bank, with the raising of key rates. The European institution intends to use it in July, but with caution: any too sudden increase could have the effect of slowing down European growth, the forecasts of which, without this lever, have been revised downwards for 2022 and 2023.

“You don’t necessarily have to aim for a high exchange rate because the euro zone is heterogeneous,” adds Rémi Bourgeot, who recalls that everyone’s ambitions can differ within European states: “When the euro was higher than it is today , for example, its rate was already considered far too low by Germany, which had a huge trade surplus.”

For Marc Touati, “it will be complicated” to restore vigor to the single European currency. The economist says he is “worried” about this because two conditions will have to be met to hope for an upturn, according to him: “The ECB will have to regain consistency on the one hand, and the European States will have to keep their commitments to on the other hand, in particular with regard to the reduction of the public debt.”

The evolution of the value of the single European currency will ultimately depend on two conditions in the coming months: the ability of the euro zone to come together with common economic objectives and overcoming the energy crisis. “We are emerging from a period of enormous dependence in this area”, concludes Rémi Bourgeot. “We must solve this supply problem, this crisis weighs and puts pressure on the euro.”

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