The list of ailments troubling the eurozone economy was already stark: the best inflation rate on record, energy insecurity and increasing whispers a couple of recession. This month, one other threat emerged. The weakening euro has raised expectations that it could reach parity with the U.S. dollar.
Europe is facing “a gentle stream of bad news,” Valentin Marinov, a currency strategist at Crédit Agricole, said. “The euro is a pressure valve for all these concerns, all these fears.”
The currency, which is shared by 19 countries, hasn’t fallen to or below a one-to-one exchange rate with the dollar in twenty years. Back then, within the early 2000s, the low exchange rate undercut confidence in the brand new currency, which was introduced in 1999 to assist bring unity, prosperity and stability to the region. In late 2000, the European Central Bank intervened in currency markets to prop up the fledgling euro.
Today, there are fewer questions on the resilience of the euro, at the same time as it sits near its lowest level in greater than five years against the dollar. As an alternative, the currency’s weakness reflects the darkening outlook of the bloc’s economy.
Since Russia invaded Ukraine in late February, the euro has fallen greater than 6 percent against the dollar as governments seek to chop Russia from their energy supplies, trade channels are disrupted and inflation is imported into the continent via high energy, commodity and food prices.
While a weak euro is a blessing for American holidaymakers heading to the continent this summer, it is just adding to the region’s inflationary woes by increasing the associated fee of imports and undercutting the worth of European earnings for American firms.
Many analysts have determined that parity is just a matter of time.
One euro can be value one dollar by the top of the yr and fall even lower early next yr, in response to analysts at HSBC, one in all Europe’s largest banks. “We discover it hard to see a silver lining for the only currency at this stage,” they wrote in a note to clients in early May.
Traders are watching to see if the euro will drop below $1.034 against the dollar, the low it reached in January 2017. On May 13 it got here close, falling to $1.035.
Below that level, the prospects of the euro reaching parity turn into “quite material,” in response to analysts on the Dutch bank ING. Analysts on the Japanese bank Nomura predict that parity can be reached in the following two months.
For the euro, “the trail of least resistance is lower,” analysts at JPMorgan wrote in a note to clients. They expect the currency to achieve parity within the third quarter.
Economists at Pantheon Macroeconomics said last month that an embargo on Russian gas would push the euro to parity with the dollar, joining other analysts linking the sinking euro to the efforts to chop oil and gas ties with Russia.
“The outlook for the euro now could be very, very tied to the energy security risk,” said Jane Foley, a currency strategist at Rabobank. For traders, the risks intensified after Russia cut off gas sales to Poland and Bulgaria late last month, she added. If Europe’s supplies of gas are shut off either by a self-imposed embargo or by Russia, the region is prone to tip into recession as replacing Russian energy supplies is difficult.
The strength of the U.S. dollar has also dragged the euro near parity. The dollar has turn into the haven of selection for investors, outperforming other currencies which have also been considered protected places for money as the danger of stagflation — an unhealthy mixture of stagnant economic growth and rapid inflation — stalks the globe. Last week, the Swiss franc weakened to parity with the dollar for the primary time in two years, and the Japanese yen is at its lowest level since 2002, bringing an unwanted source of inflation to a rustic that’s used to low or falling prices.
There are many reasons investors are in search of protected places to park their money. Economic growth is slow in China due to shutdowns prompted by the country’s zero-Covid policy. There are recession risks in Europe and growing predictions of a recession in the US next yr. And lots of so-called emerging markets are being battered by rising food prices, worsening crises in areas including East Africa and the Middle East.
“It’s a reasonably grim outlook for the worldwide economy,” Ms. Foley said. It “screams refuge and it screams the dollar.”
The Russia-Ukraine War and the Global Economy
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A far-reaching conflict. Russia’s invasion on Ukraine has had a ripple effect across the globe, adding to the stock market’s woes. The conflict has caused dizzying spikes in gas prices and product shortages, and is pushing Europe to reconsider its reliance on Russian energy sources.
Global growth slows. The fallout from the war has hobbled efforts by major economies to get better from the pandemic, injecting latest uncertainty and undermining economic confidence around the globe. In the US, gross domestic product, adjusted for inflation, fell 0.4 percent in the primary quarter of 2022.
Russia’s economy faces slowdown. Though pro-Ukraine countries proceed to adopt sanctions against the Kremlin in response to its aggression, the Russian economy has avoided a crippling collapse for now because of capital controls and rate of interest increases. But Russia’s central bank chief warned that the country is prone to face a steep economic downturn as its inventory of imported goods and parts runs low.
Trade barriers go up. The invasion of Ukraine has also unleashed a wave of protectionism as governments, eager to secure goods for his or her residents amid shortages and rising prices, erect latest barriers to stop exports. However the restrictions are making the products costlier and even harder to return by.
Prices of essential metals soar. The worth of palladium, utilized in automotive exhaust systems and mobile phones, has been soaring amid fears that Russia, the world’s largest exporter of the metal, could possibly be cut off from global markets. The worth of nickel, one other key Russian export, has also been rising.
Also within the dollar’s favor is the aggressive motion of the Federal Reserve. With inflation in the US hovering around its highest rate in 4 a long time, the central bank has ramped up its tightening of monetary policy with successive rate of interest increases, and plenty of more are predicted. Traders are betting that U.S. rates of interest will climb one other 2 percentage points by early next yr to three percent, the best level since 2007.
Compared, the European Central Bank has only just begun to send strong signals that it is going to begin to lift rates, possibly as soon as July. It will be the primary increase in greater than a decade. But even when policymakers begin, it is going to probably take a couple of policy meeting to get one in all the important thing rates of interest above zero. The deposit rate, which is what banks receive for depositing money with the central bank overnight, is minus 0.5 percent. The query being debated by analysts now’s how far above zero the bank could get before it has to stop raising rates of interest since the economy is just too fragile to support them.
In financial markets, the “concern now’s that the E.C.B. can be too late to stop a slip towards parity,” Mr. Marinov said.
The central bank has some options — it could raise rates at its next policy meeting in June to surprise the market and forestall the euro from weakening significantly further, or it could embark on a program of raising rates much higher than expected, Mr. Marinov added.
The bank’s policymakers are keenly watching the exchange rate. On Monday, François Villeroy de Galhau, the governor of the French central bank and a member of the governing council of the European Central Bank, said officials were rigorously monitoring the exchange rate since it is a “significant” reason for inflation. “A euro that is just too weak would go against our price stability objective,” he said.
The euro’s slide could also pose a challenge for American businesses operating in Europe. Last month, Mastercard said that it expected the strength of the dollar relative to the euro to shave off some potential in the corporate’s growth this yr. Johnson & Johnson said the “unfavorable” currency impact on sales could be $2.5 billion for the yr.
However the euro’s drop to parity and below isn’t assured. The currency pulled away from its lows this week after a member of the European Central Bank’s governing council suggested that the bank could raise rates in larger jumps than the expected quarter-basis-point move. On Friday, the euro was trading at $1.058.
Satirically, the euro could resist reaching and falling below parity because that level could be deemed unjustly low. In response to Mr. Marinov, parity would mean the euro was undervalued and oversold.
“The deeper we go into that territory, essentially the less convincing chasing the euro lower will turn into,” he said.