Weakening of the euro against the dollar, a trend that promises to be permanent

Since the beginning of 2021, the euro has weakened against the US dollar, falling from about $1.23 to the current exchange rate of $1.13. This represents a drop of about 9%, which is still significant, especially since these are the two major currencies in the world.

The decline also intensified in November, falling by about 3%. This decline was recorded in a context marked by violence in European capitals due to health restrictions linked to Covid-19, migrant problems at the Belarus-Poland border and the build-up of Russian troops at the Ukrainian border.

However, this decline must be viewed in a broader context. The euro is still stronger than it was two years ago, when it was worth around $1.10. It also witnessed high weekly volatility between February and April 2020, at the start of the Covid-19 epidemic, as it was between $1.07 and $1.13 so far (as of December 6), at a time when many investors turned to the US currency and where the lack of Certainty about the consequences of restrictions.

The evolution of the euro against the dollar since the beginning of 2021.
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It is notoriously difficult to explain currency movements on a weekly or even monthly basis, especially when it comes to major economies such as the United States and Eurozone countries. But we definitely need to look at what’s happening in both regions, not one or the other. Using this simple idea, there are many explanations for the recent decline in the value of the euro.

inflation differentials

The first explanation relates to the US Federal Reserve (Fed) and the European Central Bank (ECB) stimulating their economies through quantitative easing (QE).quantitative easing, or QE), which mainly involves injecting liquidity by purchasing financial assets such as government bonds from banks and other large investors. Since the beginning of the epidemic, the two central banks have intensively accelerated this process.

Toutefois, l’inflation annuelle aux États-Unis atteignant désormais un niveau de 6.2%, contre 4.1% dans la zone euro, la Fed pourrait mettre fin plus tôt que prévu à ses achats d’actifs pour volé limiter l’en The prices. In fact, an increase in the money supply is likely to increase inflation.

In fact, the Fed has already recently begun to slow the pace of quantitative easing (diminishing) with the aim of stopping it in the second half of 2022. On the other hand, the European Central Bank is considering a new quantitative easing program when the current program, totaling $2.2 trillion, ends in March 2022.

Against this background, there is a growing expectation that the US will start raising interest rates from mid-2022 to curb inflation. For her part, Christine Lagarde, President of the European Central Bank, made it clear that the increase in its rates should not occur before at least 2023.

These emerging differences in monetary policy stances in the US and the Eurozone thus far have clearly favored a stronger dollar, as quantitative easing and lower interest rates tend to devalue the currency.

Covid and politics

The second driving factor has been the recent relative strength of the US economy, relative to the eurozone, in its recovery after the pandemic. For 2021, the IMF projects 6% growth for the United States, versus 5% for the eurozone, while the forecasts for 2022 are 5.2% and 4.3%, respectively. Again, this portends a strong dollar.

It seems unlikely that Covid-19 will be subject to more lockdowns in the US (even if the number of cases increases again), but not in the eurozone, where the infection rate has risen sharply. It has increased in recent weeks in countries such as Germany, France, the Netherlands and Austria and Belgium. Austria is in quarantine again, and other countries in the eurozone may follow.

Finally, greater political stability is the ultimate driver of the dollar’s recent strength. The Biden administration has three years left to delegate and recently succeeded in passing its stimulus plan Rebuild better 1.700 billion US dollars.

By contrast, eurozone countries are currently facing a period of political instability. Germany sees 16 years of relative stability under Angela Merkel coming to an end. In France, the potential victory of a populist candidate in the upcoming presidential election is also worrying investors, as are the lingering post-Brexit trade disputes between the European Union and the United Kingdom.

All of this comes at a time when the build-up of Russian forces near Ukraine raises the possibility of a military conflict on the edge of Europe — not to mention that Russia has already curtailed gas supplies in the region and that one of the major pipelines through which Ukraine runs. In addition, major anti-vaccine demonstrations have been held in the Netherlands, Germany, France and Italy, and European governments are now under increasing pressure to control their spending.

Demonstrations against the sanitary measures erupted in November in the Netherlands.
Kenzo Tripuillard / AFP

Therefore, although short-term currency movements are difficult to predict, there are many reasons to believe that the recent period of Euro weakness will continue. This makes imports into the eurozone more expensive, especially energy. Moreover, while it has some advantages for a major exporter like Germany, the weakness of the European currency also undermines the credibility of the Eurozone as a global economic power.

What could be a game changer is for the ECB to realize that there is an inflation problem that needs to be addressed, by ending the quantitative easing experiment and starting the rate hike process. But that does not appear to be on the agenda.

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