Euro

Euro reaches parity with US dollar

  • The US dollar is benefiting from the US economy’s better prospects compared with the euro zone. The US is less exposed to the negative economic consequences of the war in Ukraine, not least because it imports little energy from Russia.
  • In addition, the Federal Reserve (Fed, the US central bank) started to tighten monetary policy earlier than its European counterpart, and at a more aggressive pace. Following another high inflation reading in June (9.1% year on year), we now expect the Fed to raise its policy rate by a further 75 basis points in July (we had previously expected a 50-basis-point rise), maintaining pressure on the euro.
  • The US dollar is also benefiting from its status as a safe haven currency amid rising fears of a global economic slowdown. 
  • The current weakness of the euro reflects investor fears of an impending recession in the euro zone. Since the start of the war in Ukraine, we have made a steep revision to our 2022 growth forecasts for the euro zone, from 4% to 2.2%. Prospects for next year are bleak, with forecast growth of only 1.6%, as carry-over effects from the strong post-coronavirus rebound in 2021 dissipate. The bloc is particularly badly affected by the recent rise in global energy prices, which is fuelling inflation in the euro zone. On July 12th the latest German investor sentiment reading was heavily negative, causing the European currency to depreciate sharply against the US dollar.
  • There is a growing risk that Russia will cut off gas supplies to Europe. Maintenance operations for the Nord Stream 1 gas pipeline that connects Russia to Germany started on July 11th, prompting a halt in Russian gas exports to Germany. There are doubts as to whether Russia will restart gas exports to Germany after the work is scheduled to be completed on July 20th. Gas rationing in the winter of 2022/23, combined with a further spike in electricity prices, would push most of Europe into a deep recession (not our core forecast).
  • European companies conduct most of their trade with other EU firms, in euro. However, they will still feel the impact of the depreciation of the euro against the US dollar: pressure on the European currency will make imports of raw materials and energy products more expensive, adding to difficulties linked to supply-chain disruptions and further fuelling inflation for both producers and consumers. We currently forecast that inflation will average 6.8% in the euro zone this year, with risks tilted to the upside.
  • There are two silver linings to a cheaper euro. First, European exporters (for instance in the aerospace industry) will partly benefit from a subdued European currency (although more expensive imports of raw materials may mitigate this positive effect). Second, the strength of the US dollar will boost the prospects of the European tourism industry by attracting American tourists in the summer holiday season.
  • In the remainder of 2022 we expect the euro to recover some ground against the dollar as the European Central Bank (ECB) begins to raise interest rates in late July. We have revised our forecast for the euro and expect that it will close the year at about US$1.07:€1 (revised from US$1.11:€1 previously). However, the euro area’s bleaker growth outlook, and a considerably slower pace of monetary tightening than in the US, will continue to constrain the single currency in the short term. We expect a more sustained appreciatory trend to begin in 2023, when the interest-rate differential with the US narrows. Over the medium term, the value of the single currency will continue to be supported by a structural current-account surplus.

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