Will the Euro Continue to Fall Below Parity?

Will the Euro Continue to Fall Below Parity?

2022-07-18 • Updated

EURUSD hit the so-called parity level of 1.0000 and dipped below it. Why there's so much talk about this? First, the euro dropping below the $1 level is rare. Still, what does the euro/dollar parity even mean? It means that the European and American currencies equal the same amount. One euro equals one dollar. 

Why is the euro's parity with the dollar a big deal? 

Since the birth of the single European currency in 1999, it has fallen below parity only once. That occurred between 1999 and 2002 when the euro plunged to a record low of $0.82 in October 2000. During the euro's relatively short history of about 20 years, it was the second most widely held currency in foreign exchange reserves after the US dollar.

What does drive the Euro's weakness? 

1. The US Federal Reserve raised interest rates to fight the highest inflation in 40 years, which reached 9.1%. That boosted the dollar's attractiveness and strength, in addition to the growing global recession fears that pushed markets to the US dollar as a safe haven. 

2. The ECB is not following the Fed-led tightening cycle. The European Central Bank is expected to raise rates at its next meeting on July 21. However, it won't be enough to keep pace with the Fed's fast speed, which is considering raising rates by 75 points, or a full 100 points (1%), at its next meeting on July 28.

3. Fears are growing that rising gas prices will make the Eurozone more vulnerable to recession risks. That explains why the euro is taking a heavy hit now. Some global banks expect a recession in the Eurozone in the third quarter of this year. 

4. High energy prices and the highest inflation in the history of the Eurozone. Energy prices in Europe rose due to the war in Ukraine, the loss of Russian oil from world markets, and Russia's cutting off gas supplies to Europe. Europe relies more on Russian oil and natural gas than the US to maintain production, industry, and electricity generation. That drove inflation in the Eurozone to a record high of 8.6% in June, making everything from groceries to electricity and utility bills more expensive while the Euro's value has weakened.

5. The US economy is stronger than the European economy. The US is on the path to economic recovery faster than the Eurozone, which is on the verge of falling into recession. 

The Euro is not the only one affected by the dollar's strength, but everything is weak against the US currency. This year, the British pound and the Japanese yen have fallen strongly against the dollar. 

What does this mean for the ECB? 

The current fall of the euro is a big headache and a terrifying challenge for the European Central Bank because the euro has weakened not only against the dollar but also against other currencies such as the Swiss franc and the Japanese yen.

The ongoing euro weakness will push already high inflation rates higher, increasing the risk of prices rooting above the ECB's 2% target. It requires more rapid rate hikes to stop the euro from bleeding against the dollar, which could add to the misery in Europe, which is already facing a possible recession. 

If Europe enters recession, especially Germany, this might stop the ECB's rate hikes, as it will worsen the situation. In the meantime, the dollar and the US economy will grow stronger, widening the gap between USD and EUR.

Will the euro continue to fall below parity?

Unfortunately, the EUR's decline against the USD is expected to continue. It may drop to $0.97-$0.95 in the near term. The euro will remain stagnant as Europe's energy crisis worsens. Even if the ECB raises rates, the Fed is faster and more aggressive.

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