The European currency is intensely looking for ways out of the price hole into which it landed after falling below the parity level with the dollar. The concession to the latter is an opportunity for the euro to "catch its breath" a bit and recover, analysts believe.
On Thursday evening, July 14, the euro plunged by 0.4% against the dollar, closing trading above parity with the USD. However, luck turned against the euro in the afternoon: it was estimated at 0.9952. This is the lowest level for the single currency recorded since 2002. During the trading process, the EUR/USD pair fell below parity, losing 0.8% against the greenback. The situation stabilized a bit on the morning of Friday, July 15. At the same time, the dollar's growth continued to put pressure on the EUR/USD pair, which was cruising near 1.0019.
According to analysts, a weak euro is the reverse side of the strengthening of the dollar. For a long time, the aggressive policy of the Federal Reserve remains the driving force of the USD. Note that the US central bank is more interested than other central banks in raising interest rates. This strategy has been recognized as the most effective for combating off-scale inflation.
This year, the euro has been plagued by setbacks: during this time, it has lost more than 10% of its value against the greenback. Throughout 2022, the EUR exchange rate has been steadily declining, and in recent days its sales have intensified. The reason is investors' fears about a full-scale gas shutdown by Russia, which could undermine the region's economy and plunge it into a deep recession.
According to experts, achieving parity (when two currencies are equivalent in value) is important for investors, since it significantly affects financial markets. However, a serious weakening of the euro increases the cost of imports and contributes to a further rise in inflation in Europe. Abrdn's investment strategist called the current situation "terrible for the eurozone." Against this background, some analysts allow the euro to fall to 90 cents or lower.
For a long time, the European Central Bank kept the EUR under pressure, calculating the risks of interest rate hikes. Compared to the Fed, it acted more slowly, yielding to its US counterpart in this matter. In recent weeks, some ECB representatives have made it clear that they are set to strengthen the euro. This has prompted speculation that the central bank is ready for a more aggressive rate hike. As a result, ECB officials left room for maneuver after the next meeting, counting on a significant rate hike in the coming month. At a time when the ECB is trying to decide whether to raise the rate by 25 or 50 bps, the markets are putting in prices its possible rise by 100 bps from the "more nimble" Fed.
Many European politicians are quite cool about the short-term fluctuations of the euro. The decisive factor for the ECB is "not the absolute level of the EUR exchange rate, but its dynamics." According to analysts, unnecessarily sharp movements shake the "fundamentally managed market". At the same time, any aggressive measures against raising rates increase the imbalance within the euro bloc, experts summarize.
However, there are optimistic scenarios regarding the medium and long-term prospects of the euro. UBS currency strategists believe that the euro will grow in relation to the greenback when the market focuses on the dynamics of the Fed's interest rates. Experts are confident that the cheapness of the euro will attract bulls again. Francesco Pesole, ING currency strategist, agrees with this, who expects the ECB to introduce measures aimed at strengthening the European currency.
During the summer, the euro exchange rate against the dollar will remain at the parity level, says Pesole. Currently, the EUR/USD pair is trying to cope with the deterioration of the global economic situation, but without success. According to Pesole, this summer, the lower limit of the pair's range will be the level of 0.9800. At the same time, by the end of the year, the EUR/USD pair may recover and go above parity amid the completion of the Fed policy tightening cycle.
The consequences of the sharp weakening of the euro have a dual effect on the region's economy. On the one hand, a significantly sagging single currency will lead to increased inflation. On the other hand, the export-oriented economy of the eurozone "will benefit from the weakening of the euro, since its exports will be attractive," the ING analyst summarizes.