Take a look: €1 = $1.
With a war on the eurozone border, an uncertain energy supply from Russia and a growing risk of recession, the pressures on the euro finally became so strong that on Wednesday it fell to parity with the US dollar – one to one exchange rate.
This is unheard of since December 2002, in the first years of existence of the currency. The aesthetically pleasing round number has become a focal point for investors.
In the currency markets, “1.00 is probably the highest psychological level,” analysts at Dutch bank ING said in a note to clients.
What is even more remarkable than breaking through this level is how quickly the euro fell against the dollar. The currency, shared by 19 European countries, has fallen more than 11% this year as the strength of the dollar is almost unparalleled.
The sharp drop in the euro came as the dollar, one of the safest places to put money for generations, strengthened against nearly every major currency in the world.
Currencies move like stocks, bonds or any other asset – investors can buy them straight when they think they will go up in value and sell when they think they will go down. They also reflect global demand for a country‘s assets in general, as buying US government bonds or Apple stock requires first obtaining dollars, and many global transactions are done in dollars. . So, as often happens in tough economic times, people looking for a safe place to put their money bought more dollars, at the expense of other currencies like the euro.
The euro was introduced in 1999 after decades of discussion and planning, with the aim of bringing unity, prosperity and stability to the continent. After two major wars in the first half of the 20th century, the argument for the euro and the wider European project was that common institutions would reduce the risk of war and crisis and provide diplomatic arenas for conflict resolution. . The euro was an essential symbol of this unity.
But like all currencies, the strength of the euro depends on people’s belief in it. This was seriously tested a decade ago when investors fled debt from heavily indebted countries and bailouts led to wrangling over fiscal policy. The crisis threatened the future of the currency, but confidence was largely restored. The euro zone, which started with 11 countries, will welcome its 20th member next year.
Over the past few months, however, a host of factors have stacked against the euro and in favor of the US dollar, which has reasserted itself as a safe haven during the economic turmoil.
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Globally, supply chains have been disrupted by the pandemic and the war in Ukraine. Since Russia’s invasion in February, prices of commodities such as oil, natural gas, wheat and fertilizers have soared, driving up food and energy prices around the world entire. This has led to the highest inflation rates in decades.
Today, central bankers in the United States and Europe pledged to reduce inflation by raising interest rates, even as the global economic outlook deteriorates. The risk of recession has been heightened by curbs on Chinese production due to Covid-19 rules, while efforts to wean Europe off Russian energy are proving elusive. These trends have made the dollar stronger while offering little to help the euro.
“The outlook remains very supportive of the dollar,” said Ebrahim Rahbari, global head of currency analysis at Citi.
The fall of the euro has amplified fears that the euro zone could fall into recession.
Last week, uncertainty over the future of Europe’s energy supply and growing fears that Russia would permanently close a critical gas pipeline to Germany pushed the euro to a 20-year low. .
But parity bets started piling up months ago. Since April, Jordan Rochester, strategist of the Japanese bank Nomura, bet that the euro would reach parity with the dollar. Similar predictions followed, notably at JPMorgan Chase and HSBC.
Then came a brief respite in the slide of the euro. Among other things, European Central Bank President Christine Lagarde outlined a clear plan to raise interest rates for the first time in more than a decade in July and signaled that the eight-year era of negative interest rates would be over early falling. Since then, policymakers have stepped up their commitment, saying that when rates rise again in September, the jump will likely be even bigger than in July.
Ultimately, this was not enough to reverse the course of the currency. “It’s hard to find much positive to say” about the euro, HSBC analysts wrote in a note to clients in early July. “The economic news is very tough.”
Around the same time, Nomura’s Rochester said he expected the euro to reach parity with the dollar by the end of August. In the end, it went much faster.
“That’s very much human psychology,” Rochester said. There’s no market-based reason why parity matters – “it’s just a round number,” he added. But this could be the start of a period similar to the currency’s early years, when trades ranged from 82 US cents to 1 dollar against the euro.
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Back then, in the early 2000s, before the euro existed in the form of banknotes and coins and was just a virtual currency, the weak exchange rate undermined confidence in the new change. The European Central Bank even intervened to try to strengthen it.
Today, there are fewer questions about the resilience of the euro as progress has been made in strengthening the union. The central bank’s commitment to preserving the currency a decade ago has not been significantly tested since.
But the weaker currency poses an additional headache for the European Central Bank, as it will add to inflationary pressures in the region by raising the cost of imports. Central bankers say they are not targeting an exchange rate level, but it will be difficult for them to stop the currency’s decline in words because the forces pushing the dollar higher have been so strong.
As US inflation nears its highest rate in four decades, the Federal Reserve has intensified its monetary policy tightening with significant interest rate increases. Fed Chairman Jerome H. Powell told a conference in late June that he expected his benchmark rate to hit 3.5% this year. He added that there was a risk that the central bank would go too far in raising rates to cool the US economy, but letting inflation stay high was a bigger risk.
As Mr Powell spoke, he sat next to Ms Lagarde at the European Central Bank’s annual retreat in Sintra, Portugal. While she agreed with him on the risk of continued inflation, she did not match his commitment and clarity on how interest rates could rise in the euro zone. Investors can only speculate on what might happen by the end of the year.
But even before the first rate hike, on July 21, the growing risk of a recession in the euro zone has investors wondering how far the bank can raise rates before having to halt again.
“The ECB will struggle to keep pace with the Fed’s decision to fight inflation or raise rates,” said Citi analyst Rahbari.
As the European Central Bank plans its rate hikes, it must also keep an eye on sovereign bond markets. There have been concerns about the impact of rising interest rates and the end of central bank bond-buying programs on the bloc’s most indebted members.
In Italy, for example, borrowing costs rose sharply in June, and officials are trying to discern how accurately those moves reflected the risk in Italy’s financial situation and what has been called fragmentation, or rapidly diverging interest rates among eurozone members that would make monetary policy less effective. The bank is preparing a new policy tool to deal with this fragmentation, which central bankers see as a disconnect between economic fundamentals and government borrowing costs.
“It will be another testing period for the eurozone” and its central bank over the next year, Rahbari said.