In what direction is the euro heading?

By Al Mayadeen English
Source: Agencies
17 Jul 2022 08:31

For the first time in two decades, the euro and dollar parity and the latter could fall below it.

In what direction is the euro heading?

The euro's drop against the dollar, precipitated by the war in Ukraine and rising risks to the EU economy, has brought the two currencies to parity for the first time in two decades.

On Thursday, the European single currency fell to $0.9952, a low not seen since the end of 2002, the year it was officially created. However, traders believe the euro will recover if many obstacles are overcome in the next months.

The first hurdle that must be overcome is avoiding a halt in Russian gas supplies to Europe, which would cause energy prices to skyrocket and force eurozone countries to curtail some industrial activity.

"If gas flows from Russia normalize, or at least stop falling, following the end of the Nord Stream 1 maintenance shut-down next week, this should somewhat decrease market fears of an imminent gas crisis in Europe," Esther Reichelt, an analyst at Commerzbank, told AFP.

On Thursday, French President Emmanuel Macron stated that Russia was using energy "as a weapon of war."

If Nord Stream 1 is not restarted, "the euro will weaken as the economic shock waves would be felt globally as the European energy issue may very possibly precipitate a recession," predicted Stephen Innes, an analyst at SPI Asset Management.

ECB wake-up call

"Recession would inevitably mean that the market becomes even more concerned about fragmentation risks in the eurozone," added Jane Foley, a foreign exchange specialist at Rabobank.

The European Central Bank (ECB), like other central banks, is trying to avoid suffocating the economy by raising interest rates too quickly.

However, it must be concerned about the possibility of debt market fragmentation, with huge disparities in borrowing rates throughout the eurozone.

To date, the ECB has maintained an ultra-easy monetary policy to boost the economy, but the US Federal Reserve has raised rates and promised to continue doing so to combat inflation.

It will make its monetary policy decision on Thursday, and it has hinted that interest rates would be raised for the first time in 11 years.

"If the ECB is aiming to give the euro a boost, it will have to deliver a 50-bp hike in July and/or signal that 75-bp moves are on the cards for September," S&P analysts said in a note.

"Speedier policy adjustments now would help anchor inflation expectations, reducing the risk of needing a restrictive policy stance further down the line," they added.

Fed slowdown

According to Berenberg experts, the euro's decline is primarily due to the strength of the dollar, which has "appreciated strongly against a broad basket of currencies since mid-2021."

The dollar has benefited from the Federal Reserve's tightening of monetary policy to contain inflation, which reached new highs in June.

"Markets are speculating that the Fed may raise rates by 100bp instead of 75bp at its next meeting on 27 July," noted Berenberg. "If so, this could strengthen the dollar further."

UniCredit added: "Towards year-end, prospects of declining inflation and more-balanced messaging from central banks as the cyclical peak of official rates near should support a return of risk appetite and ease USD demand."

They believe that if this occurs, the euro will drift away from parity in the final months of 2022.