The euro fell to a two-decade low yesterday as high energy prices, recession fears and a dovish European Central Bank (ECB) pushed the currency closer to parity with the dollar.
The euro’s 1.5 percent slide took it below $1.03 in afternoon trade, its weakest since late 2002, a move that will add to inflationary pressures across the euro zone as the ECB prepares to hike rates.
ECB President Christine Lagarde and Chief Economist Philip Lane have led markets for a quarter-point rate hike later this month, but as the Federal Reserve moves forward with more aggressive hikes, it may not be enough to protect the currency, complicating efforts Tame inflation and support the economy.
“The ECB isn’t quite there yet,” said Ronan Costello, head of FX strategy at Bank of Ireland.
“They have a real fight ahead of them to fight inflation without hurting the economy. This pace may not be enough to keep the euro off parity.”
The weaker euro means both businesses and consumers expect even higher prices this summer and beyond as currency fluctuations spill over into the broader economy.
The problem goes beyond more expensive vacations to Disney World or New York City. All American imports, from parts and supplies to raw materials and services, will cost more for companies, who will pass the price increase on to their customers.
Because energy and commodities, like groceries, are priced in dollars, a sharp fall in the euro automatically means that everything from the gas pump to the grocery register becomes more expensive.
It’s no coincidence that the euro has fallen 11 percent against the dollar, from $1.14 to below $1.03, since the Russian invasion of Ukraine boosted oil and gas prices.
But the key driver behind all of this – at least for forex traders – is the interest rate differential between the ECB and the Fed.
While the ECB is taking a phased approach to reining in record-high inflation, fearing it will slow down a sluggish post-pandemic economic recovery, the Fed has already hiked rates by 1.5 percentage points this year.
Fed Chair Jerome Powell’s ‘hawk talk’ has only widened the yield gap between euro and dollar-denominated assets as investors believe the US will rise higher and faster.
But while the market has focused primarily on inflation for most of this year, in recent weeks attention has shifted to weaker economic data out of the Eurozone, which heralds a slowdown or even a recession next year.
Now markets are expecting the ECB to tighten 1.4 percentage points instead of 1.9, only increasing pressure on the currency.
With inflation at 8.6 percent in the eurozone and 9.6 percent in Ireland – the urgency to contain prices is obvious, but the ECB does not want to derail even a weak recovery, hence the modest approach to rate hikes.
The Fed is putting pressure on around the world. The yen fell to a 24-year low while other central banks — including the Reserve Bank of Australia — hiked rates for a third straight month on Tuesday.
“We’ve had so many central banks going up in these big strides that you’re now talking about reverse currency wars,” Rabobank FX strategist Jane Foley said, referring to where central banks are going up to stop their currencies falling.
“It could get worrying for a number of currencies,” she added, particularly if the Fed rushes into big rate hikes in the coming months.
In view of the seemingly ingrained dollar dominance, households and companies will have to adapt in the short term, at least until the ECB’s interest rate policy takes effect.
But it’s not all bad news. Exporters to the US and countries that peg their currencies to the dollar – like the Gulf States – are seeing the benefits of a weak currency.
“The dollar rate is probably not as important as the pound sterling as the typical Irish SME will export to the UK first,” said John Finn, managing director of Treasury Solutions.
“The few who export to the US have a really good ride with it. But there is a hidden burden of energy costs that is bad for everyone.”
That energy exposure was highlighted yesterday with another big 17 percent rise in natural gas prices in Europe, which will only push inflation higher this month.
And the boost some companies could get from more competitive exports will be far from enough to offset the downside of a weak euro to the rest of the economy.
Nevertheless, a change in dynamics is possible. Some commentators see the ECB making up for lost time by steadily raising rates as they get going, which in theory should support the euro and alleviate some of the imported inflation.
Alternatively, as markets move from focusing on geopolitical risks to economic risks such as a global downturn, dollar assets could be viewed as a less safe haven. “The dollar tends to peak early in the rate hike cycle,” Mr. Costello said. (Additional coverage by Reuters)
https://www.independent.ie/business/world/euro-heading-for-parity-with-dollar-after-massive-fall-41816730.html Euro heads for parity with dollar after massive decline