On Tuesday, Croatia cleared the final hurdle to achieve its long-standing ambition of becoming the 20th member of the single currency, a move its central bank chief Boris Vujčić said would bring “more security” and “improve the standard of living of our citizens.
But while Zagreb wants in, the currency markets want out.
The euro is now worth just one dollar for the first time since 2002, reviving memories of its rough early years, when it fell so low that traders dubbed it the “bathroom currency” and major central banks launched concerted intervention to instill faith in the project.
The euro, which accounts for a fifth of global foreign exchange reserves and a quarter of global bond issuance, is no longer being dismissed as a doomed endeavor. However, the peg to the dollar highlights the widening gulf between the economic prospects of the US and the eurozone, which is more exposed to the fallout from the war in Ukraine. The weakness of the euro, which will push up the price of imports, will worry politicians already facing record inflation.
“There is a sense that the eurozone economy just won’t be strong enough and will be part of the global slowdown,” said Alan Ruskin, chief international strategist at Deutsche Bank.
The euro’s rapid decline, from $1.19 last year to $1 on Wednesday, comes amid fears that Russia could cut off its already reduced supply of natural gas to Europe, forcing energy rationing and triggering a painful recession throughout the region.
“We keep buying dollars when we start to worry that the global economic landing might be harder, not softer,” said Kit Juckes, currency strategist at French bank Société Générale. “The world’s other major currency [the euro] it is greatly handicapped by the fact that its energy crisis is potentially of a completely different magnitude.”
The dollar soared against most currencies, not just the euro, thanks to a series of rate hikes by the Federal Reserve, culminating in a 75 basis point hike last month that pushed the target range to between 1.5% and 1.75%. . “Monetary policy in the US still drives the euro more at this stage than the European Central Bank,” said Dirk Schumacher, head of Europe macroeconomics research at Natixis. “The Fed is the main driver of the euro.”
The euro has fared better on a trade-weighted basis, where it is measured against a basket of 42 currencies, falling just 1.6 percent since the turn of the year, compared with 11 percent against the dollar.
The ECB has yet to raise rates from its record low of minus 0.5 percent, but is expected to do so next week with a modest quarter-point increase.
Banque de France Governor François Villeroy de Galhau, who sits on the ECB’s governing council, told France Info radio on Wednesday that a weaker euro was a mixed blessing. “It’s good news for activity as it supports exporters, but unfortunately pushes inflation up a bit,” he said.
A series of hikes by the Bank of England has not protected the British pound from the strength of the dollar. “The pound has also depreciated 11 percent against the dollar since the end of last year,” said Vítor Constâncio, a former ECB vice president.
Robin Brooks, chief economist at the Institute of International Finance, a banking trade group, said currency traders were betting that a severe recession later this year would prevent the ECB from raising rates much above zero. “The cumulative damage to the eurozone is already great,” said Brooks, a former Goldman Sachs currency specialist. “Forex markets are leading the rest of the trading complex on this.”
Highlighting the pessimism, the ZEW think tank’s monthly gauge of investor expectations for the German economy in June fell to its lowest level since the eurozone’s sovereign debt crisis began in 2011.
The impact of the strong dollar is especially great at a time when the cost of energy, which is priced in dollars on international markets, is skyrocketing. Deutsche Bank has estimated that the eurozone will suffer a negative impact of 400,000 million euros in its trade balance this year if prices remain at current high levels.
The single currency’s decline also fuels inflation, pushing up the price of imports and contributing to a record 8.6 percent rise in consumer prices in the year to June.
For every 10 percent depreciation of the euro against the dollar, an additional 0.2 percentage point is added to eurozone inflation in the coming year, Schumacher estimated. “It’s not a game changer, but it all helps and I’m sure it would be welcome at the ECB if the euro recovered,” he added.
While the euro’s decline against the dollar mainly reflects cyclical changes in the world economy and not structural changes, some economists worry that the energy crisis could have a lasting impact on Europe’s competitiveness. Maria Demertzis, deputy director of the Brussels Bruegel think tank, said: “If the change in the energy mix facing the EU changes its competitiveness, that could mean that the euro starts to go down, and that is something to watch.”
Before inflation spiked to 40-year highs in much of Europe and North America, a weaker currency was seen as an economic advantage.
Just three years ago, former US President Donald Trump accused the ECB of “unfairly” manipulating the euro lower to boost the region’s exporters by making dovish comments on policy. With price pressures mounting, that is no longer the case. “It’s not at all obvious that the US is particularly unhappy with the level of the dollar,” said Francesca Fornasari, head of currency solutions at Insight Investment.
Croatia will join the single currency early next year.