American tourists vacationing in Europe this summer can look forward to a hefty budget for dinners, hotels, and souvenirs. Compared to a year ago, for every dollar they spend in Europe, they can spend 15 percent more. With this percentage, the euro has depreciated against the US dollar in one year.
Since a week, the euro exchange rate has been under extra pressure: about 3 percent has fallen. On Monday, a symbolic limit came into view: 1 euro is 1 dollar. The euro briefly touched $1.005, and then bounced back a bit. Many analysts assume that ‘parity’ (1 euro = 1 dollar) will be reached soon, possibly this week. And that the euro will then be worth less than the dollar. This situation last occurred in 2003.
What does this say? It is about the euro, but also about the dollar.
Also read the column: The dollar may just run away again
First the European side of the story. Some analysts have been predicting parity for months now. This is because the Russian invasion of Ukraine is a major blow to economic growth in Europe. The Institute of International Finance, a club of major banks, already predicted in March that the euro exchange rate in dollars would fall below 1. If the economy in a currency area deteriorates, investments in that currency will lose value. The currency itself then falls.
In recent weeks – and certainly the last few days – the discussion about an impending recession in Europe has flared up. High inflation affects the purchasing power of consumers, who are spending less. On top of that, there are imminent, possibly serious, shortages of (Russian) gas. Germany, Europe’s economic engine, is deeply concerned about the gas supply to its industry.
ECB slower than Fed
In addition to the threat of recession, the European Central Bank has been slow in raising interest rates to tame inflation compared to the US Fed. Eurozone interest rates will rise for the first time this month, while the Fed has been raising rates since March. The lower the interest rate is somewhere, the fewer investments are proportionately profitable – and that also depresses the price of the currency.
Then the American side of the story. There is also a risk of recession there, but the US is less susceptible to the effects of the war in Ukraine because of its location. US job data last week was surprisingly positive, reinforcing belief among currency traders that the Fed will continue to raise interest rates aggressively to tame inflation.
Also read the analysis: The ECB’s interest rate hike is a gamble. Either inflation will fall, or Europe will face a recession
Furthermore, the dollar has a reputation as a ‘safe haven’ in the financial markets. In times of great turmoil, the dollar rate always benefits from capital flowing into the US. Not only from Europe, but also from elsewhere, such as emerging countries. Other ‘safe havens’ are the Swiss franc and the Japanese yen. The Swiss franc has been more expensive than the euro since last week. Anyone who goes on holiday in the already expensive Switzerland this summer can wet their chest.