August 12, 2022

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Why is the euro sinking?  .. Reasons for a single currency to become par with the dollar

Why is the euro sinking? .. Reasons for a single currency to become par with the dollar

As the US economy collapsed during the 2008 global financial crisis, one euro was equal to 1.6 dollars. Now, a combination of Europe’s exposure to the front lines 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 fell below $1.02 for the first time since 2002, in the early years of its emergence as a single European currency.

Why is the euro sinking?

An analysis by the Bloomberg agency found that one of the main factors of the current weakness is that Europe is heavily affected by the war in Ukraine, which has triggered an energy crisis and could lead to a long and deep recession. The European Central Bank is in a difficult position as it aims to raise borrowing costs for the first time since 2011 as it tries to control inflation and slow the recession. Meanwhile, the US Federal Reserve is rapidly raising interest rates. That pushes yields on U.S. Treasuries higher than European debt yields, driving investors into the dollar and away from the euro.

And, according to the analysis, the dollar benefits from its safe-haven status, meaning the euro will continue to slide as the war continues and its consequences worsen.

For years, policymakers have welcomed a weaker currency as a way to spur economic growth because it makes the group’s exports more competitive. But now, with elevation Inflation in the Eurozone At its highest levels, currency weakness is undesirable because it increases price gains by making imports more expensive.

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In June, consumer prices in the eurozone rose 8.6% from a year earlier. Some policymakers have highlighted the euro’s weakness as a risk to the ECB’s goal of bringing inflation back to 2% over the medium term, even without an ECB exchange rate target.

However, when measured against currencies other than the dollar, the euro appears more flexible.

1:1 status

Parity is a psychological limit to the market. The euro fell against the dollar for the first time in December 1999, less than a year after the creation of the European currency.

Like now, analysts then pointed to a widening between German and US bond yields and strong growth in the US. This influenced the Europeans, who saw in the single currency an important political project and a rival to the dominant dollar.

Today, the Euro is one of the world’s major currencies for transactions and balances.

Some analysts predict the single currency could fall to 90 US cents if Russia escalates the crisis by cutting off more gas supplies from Europe. Since early July, options traders have placed heavy bets around the $0.95 level, with $0.9850 a possible short-term bottom, according to trading data from the Depository Trust & Clearing Corp.

According to strategists at Deutsche Bank, a slide to $0.95 – $0.97 would match the highest exchange rates seen since late 1971 under the “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.

Does anyone convert?

The key to changing the euro’s trajectory is narrowing interest rate differentials with other global bond markets. At a time when the central bank raised rates by 150 basis points in three months, the European Central Bank has yet to move, keeping its key rate negative.

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Although monetary policymakers in Europe have signaled the start of a tightening cycle, including a possible 50bp hike in September, doubts are growing about its sustainability.

It is more difficult for the European Central Bank to raise interest rates than other central banks. Because if investors start to question the debt sustainability of European countries, there is a risk that the borrowing costs of the highly indebted eurozone countries will spiral out of control.

Is the Euro in an existential crisis?

The single currency has faced challenges as a concept in the past. Since its inception, naysayers have pointed to the difficulties of managing a monetary union for diverse economies. This became apparent during the 2012 Eurozone sovereign debt crisis, 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 concerns about the bloc’s backlash. 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.

Although central banks took action in 2000, direct intervention to support the euro in foreign exchange markets was rare.