EXPLAINER: What is the impact of the parity of the euro with the dollar?

The euro is near parity with the dollar, falling to its lowest level in 20 years and even briefly touching a one-to-one exchange rate with the US currency this week. It is a psychological barrier in the markets.

The euro is near parity with the dollar, falling to its lowest level in 20 years and even briefly touching a one-to-one exchange rate with the US currency this week.

It is a psychological barrier in the markets. But psychology matters, and what the euro’s decline underlines is the hunch of the 19 European countries using the currency as they battle an energy crisis caused by Russia’s war in Ukraine.

Here’s why the fall of the euro is happening and what impact it could have:

WHAT DOES EURO AND DOLLAR PARITY MEAN?

This means that European and American currencies are worth the same amount.

A currency’s exchange rate can be a verdict on the economic outlook, and those in Europe are fading. Expectations that the economy would rebound after turning the corner from the COVID-19 pandemic are replaced by predictions of recession.

More than anything, rising energy prices and record inflation are to blame. Europe is much more dependent on Russian oil and natural gas than the United States to run industry and generate electricity. Fears that the war in Ukraine will lead to a loss of Russian oil on world markets have pushed oil prices higher. And Russia has cut natural gas supplies to the European Union, in what European leaders have described as retaliation for sanctions and arms deliveries to Ukraine.

Energy prices pushed inflation in the euro zone to a record high of 8.6% in June, making everything from groceries to utility bills more expensive. They also raised fears that governments could ration natural gas to industries like steel, glassmaking and agriculture if Russia further reduced or shut off gas taps altogether.

The sense of doom grew when the main Nord Stream 1 pipeline from Russia to Germany was closed on Monday for scheduled maintenance, raising fears the Kremlin could resume deliveries this month.

“What does the fall of the euro say? It is becoming increasingly clear that the Eurozone is headed for recession,” Robin Brooks, chief economist of the Banking Trade Group at the Institute of International Finance, tweeted on Tuesday.

WHEN WAS THE LAST TIME THE EURO WAS EQUAL TO THE DOLLAR?

The Euro has not been valued below $1 since July 15, 2002. It is now below $1.01.

The European currency hit its all-time high of $1.18 shortly after its launch on January 1, 1999, but then began a long slide, breaking the $1 mark in February 2000 and hitting a record low of 82.30 cents in October 2000. It broke above parity in 2002 as large trade deficits and accounting scandals on Wall Street weighed on the dollar.

Then as now, what appears to be a euro story is also in many ways a dollar story. This is because the US dollar is still the dominant currency in the world for trade and central bank reserves. And the dollar has hit 20-year highs against the currencies of its major trading partners, not just the euro.

The dollar also benefits from its status as a safe haven for investors in times of uncertainty.

WHY IS THE EURO FALLING?

Many analysts attribute the fall in the euro to expectations of rapid interest rate hikes by the US Federal Reserve to combat 40-year highs in inflation, which hit an annual rate of 9.1% Wednesday.

When the Fed raises interest rates, interest-bearing investment rates also tend to rise. If the Fed raises rates more than the European Central Bank, higher interest yields will draw investors’ money away from euros into dollar-denominated investments. These investors will have to sell euros and buy dollars to buy these assets. This causes the euro to fall and the dollar to rise.

The ECB has announced that it will raise interest rates next week and add another increase in September. But if the economy slides deeper into recession, that could halt the ECB’s run of rate hikes. Meanwhile, the US economy looks more robust, which means the Fed could continue to tighten and widen the spread.

WHO WINS?

American tourists in Europe will find cheaper hotel and restaurant bills and admission tickets. The weaker euro could make European export goods more price competitive in the United States. The US and the EU are major trading partners, so the exchange rate change will be noticed.

In the United States, a stronger dollar means lower prices for imported goods – from cars and computers to toys and medical equipment – ​​which could help moderate inflation.

“Parity makes it easier for us, and a lot more money goes a lot further now, so we can do a lot more on our journey,” said John Muldoon, who was visiting Rome this week from Delaware.

Olivia Navarret, another Roman tourist from Pennsylvania, said the exchange rate meant a shirt she bought was cheaper.

“It’s cheaper to come here and buy stuff,” she said. “So it’s better to come here, I guess, and spend money here than to spend money in the United States”

WHO LOSES ?

American companies that do a lot of business in Europe will see the revenues of those companies decline when and if they bring those revenues back to the United States. If the euro income stays in Europe to cover the costs there, the exchange rate becomes less of an issue.

A major US concern is that a stronger dollar will make US-made products more expensive in foreign markets, widen the trade deficit and reduce economic output, while giving foreign products an edge. on prices in the United States.

A weaker euro can be a headache for the European Central Bank as it can mean higher prices for imported goods, especially oil, which is priced in dollars. The ECB is already being pulled in different directions: it is about to raise interest rates, the typical inflation remedy, but higher rates can also slow economic growth.

The Associated Press