Introduction: Euro exchange rate against the US dollar has fallen to 1:1 again recently. The "equal value" of the euro and the US dollar is mainly caused by multiple factors such as the European energy crisis, the interest rate spread and the strengthening of the US dollar, which will further push up the euro zone inflation rate, exacerbate the imbalance of Europe's trade, and increase difficulties for the European Central Bank to make adjustments; it will also aggravate the turmoil in the international market, especially emerging countries, and trigger capital outflows and debt crises.
On July 12 this year, the euro fell to 1:1 against the US dollar. The last time the euro and the dollar were "equal" was December 2002 2002. This round of euro depreciation is mainly caused by multiple pressures such as the European energy crisis, interest rate spreads and the strengthening of the US dollar. The result will not only damage the European economy, but also intensify the turmoil in the international market.
trigger
At present, the primary focus of Europe is on energy issues. After the outbreak of the Russian-Ukrainian conflict, EU reduced imports of Russian oil and natural gas , triggering a surge in energy prices, euro zone fell into energy crisis . The possibility of Russia's interruption of energy supply to Europe cannot be ruled out. In addition, the transformation of Europe's energy structure has led to a continuous decline in traditional energy output, making it difficult for Europe to find suitable alternative energy sources in the short term.
Image source: China Daily
The continued increase in interest rate spread between the euro and the US dollar is also a major driving factor for the depreciation of the euro. As of the end of June this year, the Federal Reserve has raised interest rates three times. By contrast, the ECB did not adopt such radical policies any time soon. The Fed's repeated hikes of interest rates have led to a spread between the US dollar and the euro, bringing pressure on the euro to depreciate. The spread between the U.S. 10-year government bonds and the European 10-year AAA government bonds have risen from 1.41% in mid-June to 1.7% in mid-July.
In addition, the strengthening of the dollar also puts additional pressure on the euro. At present, the Russian-Ukrainian conflict has led to an increase in risk aversion in the international market, and the world is facing high inflation, and concerns about economic recession are intensifying. In this case, the US dollar becomes a safe haven. Global demand for the US dollar is increasing, causing the dollar index to soar, resulting in the depreciation of the euro. On July 15, the US dollar index rose to 108.57 points, up 13.6% from the beginning of this year, setting a 20-year high.
htmlOn July 28, the Federal Reserve raised interest rates again by 75 basis points, causing the US dollar to further strengthen. In Europe, which is deeply in the energy crisis, the euro will further weaken.Image source: China Daily
"pain"
Euro and US dollar "equal value" will damage the euro zone economy in many aspects.
First, the already out of control of the euro zone will further rise. The price of commodity soared under the Russian-Ukrainian conflict, coupled with the strengthening of the US dollar, will intensify the euro's inflation level through imports. In June, the eurozone consumer price coordination index rose from 8.1% in May to 8.6%, setting a record high. But aside from energy and food prices, the eurozone's core inflation index in June was 3.7%, down from 3.8% in May.
In addition, within the euro zone, the higher the inflation rate of countries that rely on international energy supply. For example, France mainly relies on domestic nuclear power, and its inflation rate in June was only 6.5%; Spain is a major natural gas importer, with its inflation rate as high as 10.2%; while the inflation rate of the Baltic countries that rely heavily on Russian energy imports exceeded 20%.
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Second, the trade imbalance in the euro zone will further intensify, and the overall economic situation will deteriorate. In theory, a weaker euro may benefit EU exporters and narrow the trade deficit . But at the same time, a stronger dollar and high commodity prices will significantly increase import costs. This not only offsets the gains, but will also expand the trade deficit.
As of May this year, the EU has experienced a trade deficit for seven consecutive months. During this period, Germany's imports were 126.7 billion euros, increased by 28% year-on-year, and exports were 125.8 billion euros, a year-on-year increase of only 12%. After excluding seasonal impact, Germany's trade deficit in May was close to 1 billion euros, the first monthly foreign trade deficit since 2008. At the same time, France is also facing similar problems.France's trade deficit reached a record 13.1 billion euros in May, and the cumulative trade deficit reached 113.9 billion euros in the past 12 months. As the "engine" of the growth of the eurozone, Germany's economic performance is very important. Since 55% of its natural gas comes from Russia, Germany's economic model will be unsustainable without cheap Russian energy, which will cause big trouble for the European economy.
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3, the continued weakness of the euro will undoubtedly bring more problems to the European Central Bank. To prevent further depreciation of the euro, the ECB must raise interest rates faster and more dramatically. But because the euro is a single currency, the ECB's decision to raise interest rates requires weighing the economic status and prospects of all member states in the euro zone.
In addition to the threat of inflation and economic recession, the ECB is currently facing a risk of significant differences in sovereign debt returns among countries. In June this year, the yield on Germany's 10-year government bonds was 1.7%, while the yield on Italy's 10-year government bonds has risen above 4%, which means the interest rate spread between different countries in the euro zone has widened significantly. And when interest rate spreads widen, it will be more difficult for the eurozone to refinance its debts, which may trigger the sovereign debt crisis . Therefore, the ECB is much more difficult than the Fed in planning interest rate hikes.
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overflow
In addition to damaging the euro zone economy, the "equal value" of the euro and the US dollar may also trigger turmoil in some emerging markets.
Euro and US dollar will prompt global capital to return to the United States. This will exacerbate capital outflow pressures in other economies, especially emerging market economies, resulting in exchange rate fluctuations and currency depreciation in emerging markets. Data from the International Finance Institute showed that the net outflow of emerging market portfolios in June was US$4 billion, with capital outflows for four consecutive months.
In addition, most foreign debts in emerging market economies are denominated in US dollars. The stronger US dollar will inevitably increase their debt repayment pressure and refinancing costs, leading to an increase in debt risks, and in severe cases, it may also trigger a sovereign debt crisis. The latest World Economic Outlook report released by the International Monetary Fund on July 26 pointed out that the fiscal space of many emerging markets and developing economies has been repeatedly compressed, and 60% of low-income countries are likely to have fallen into or are facing a government debt crisis.
Image source: China Daily
Editor | Song Ping Xinxin
Editor | Zhang Zhao
Interns Feng Xiaoyuan, Tong Yafan, and Yin Kangjun also contributed
This article is an exclusive commission for China Observation Think Tank, with the English version titled "Parity pains".
Source: China Daily China Observation Think Tank
