The euro has been on a bit of a roller coaster this week. It hit a five-month high at the start of the week and slipped back into the red, then rebounded to a fresh multi-month high of $1.0736 on Thursday. However, it’s been hit again by weaker US Dollars. And it looks like the Euro’s rally may be over.
The dollar’s surge this year has been powered by the Fed’s aggressive interest rate increases and the currency’s status as a safe haven for investors. But it’s also been fueled by worries over a global recession. Especially with the war in Ukraine, the energy crisis in Europe, and a possible fallout from accounting scandals on Wall Street, foreign exchange markets have been jittery.
The dollar’s soaring has sparked fears that its strength will hurt Americans and Europeans. It’s also been a boon for trade. The stronger dollar makes imports and exports more affordable for Americans and more expensive for Europeans. But it could also make American products less competitive in overseas markets. In addition, it provides a buffer for soaring inflation, which is a key factor in a global recession.
But the US economy is still robust. The FOMC has estimated that it expects inflation to drop to 2.80% in 2023. The IMF projects that it will drop to 3.50%. And the EU’s GDP has shown growth of 0.3% in the third quarter. But the euro is still below parity with the dollar, which means it is more expensive for Europeans to buy goods in the U.S.
The ECB has also raised rates recently. It announced a 50-basis point increase in December and a 75-basis point hike last month. It also outlined plans to raise the key interest rate by a half point in September. But it’s unlikely it will be able to increase it by that much.
The euro’s slide has come at a time of heightened inflationary pressures, which could be a problem for the ECB. The inflation rate fell 0.50% in October, which was below the ECB’s previous forecast of 8.20%. It’s still well above the 3% rate needed to stabilize inflation. It’s a positive development for the euro, but it’s going to have a dampening effect on European growth.
A weaker euro would reduce the competitiveness of European exports to the U.S. and widen the trade deficit. The euro’s decline will probably feed inflationary pressures and will likely push the euro even lower over the next few years. But it’s possible that the euro will find some relief as the dollar strengthens.
In addition to its role as a counter-cyclical safe haven, the dollar is enjoying the benefit of being the world’s dominant currency for trade and central bank reserves. Buying the dollar is a safe way for Americans to gain access to the hawkish Fed and for Europeans to invest in the U.S. This is one reason why the US Dollar Index has soared nearly 12% this year.