The euro, which fell below parity with the U.S. dollar in September 2022, is recovering thanks to a cooling energy market, reduced fears of recession and a hawkish stance of the European Central Bank (ECB).
The euro, which has gained almost 13% in the last 3.5 months, was also helped by a general weakening of the U.S. currency: the dollar ICE index, which rose to a 20-year high in September, has since lost about 10%.
As of 11:15 a.m. on Monday, the euro/dollar pair was trading at $1.0895, up from $1.0857 at the close of the previous session.
The Federal Reserve (Fed) raised its benchmark rate by 425 basis points last year, the fastest rate hike for a single year in four decades, the Financial Times noted. The widening of the spread between U.S. and other interest rates triggered an influx of investor funds into U.S. assets, which provided strong support for the U.S. dollar. This put additional pressure on the euro, already weakened by the rise in energy prices due to the full-scale war unleashed by Russia against Ukraine and fears of a downturn in the region’s economy.
Recently, however, trends have changed somewhat.
“For several years, there were virtually no alternatives to the dollar,” says Andreas König, head of currency markets at Amundi. – Now the capital returns to the economy outside the U.S., as there are other attractive options for investment.
In particular, the expert notes the increase of foreign capital inflow to China after the lifting of quarantine restrictions by the authorities of the country. China’s decision to abandon its policy of zero tolerance for COVID-19 provoked higher forecasts for the global economy by leading experts. This also puts pressure on the dollar, which usually strengthens in periods of macroeconomic stress.
At the same time, the outlook for Europe has recently improved, notes the FT. Gas prices have fallen due to a mild winter in the region, allowing the economy to avoid the expected deep recession.
Emerging signals of weakening inflation in the U.S. means that the U.S. Central Bank could continue to slow the pace of rate hikes. In December, the Fed increased the rate by 50 bps. – up to 4,25-4,5% per annum after its rise by 75 bp following the results of the previous four meetings.
The market expects further reduction in the Fed’s policy tightening and believes that the central bank may begin to reduce the rate in the second half of this year.
The ECB raised key interest rates by a total of 250 bps last year.
“Lower rates will eliminate a major advantage the dollar has,” said MUFG currency analyst Lee Hardman, who expects the ECB’s deposit rate to rise to 3.25 percent from 2 percent by the middle of this year. – Last year, the Fed was the leader among other global central banks in raising rates, but now the ECB has become more hawkish.
Strengthening the divergence in policy between the Fed and the ECB could lead to a rise in the euro to $ 1.12 by early 2024, said Hardman.
The expert, however, cautions against excessive optimism about the euro exchange rate against the dollar, given the continuing threat of rising energy prices that could affect the volume of European trade.
