Why the Euro Is Closing in on Parity With the US Dollar Again

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(Bloomberg) — Since the euro came into existence in 1999, the currency has traded at equal value to the US dollar only a handful of times. The last instance was in 2022, after Russia’s full-scale invasion of Ukraine sparked an energy crisis in Europe and provoked fears of a recession, plunging the currency pair to a 1:1 ratio for the first time in two decades. Now, market watchers see a chance it will happen again. 

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Why is the euro falling?

Europe is one of the regions most vulnerable to US President-elect Donald Trump’s threat to increase tariffs on US imports. The US is a big buyer of the European Union’s exports, from cars to chemicals to luxury handbags, and tariff hikes would weigh on the single market’s already weakening economy. Growth has been anemic in the euro area, and interest rates there are lower than in other developed economies. (Lower interest rates mean euro-denominated assets earn less interest, reducing demand for the currency.) In addition, political turmoil in France and Germany — the two biggest economies in the EU — has increased the risks of investing in those countries and made it harder for their governments to fix structural issues holding back growth. 

The euro’s weakness is also related to the broad-based strength of the US dollar. Demand for assets denominated in the US currency has been growing on expectations that the Trump administration’s policies will stoke economic growth and corporate profits in the US. The relative outperformance of US assets is a trend that’s weighed on most major currencies in the year to date. 

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How likely is euro-dollar parity? 

In the wake of the US election, at least 10 banks are expecting a weaker euro, with some even predicting a move below the 1:1 threshold in 2025. But the expectation of parity is not unanimous. There’s still a lot of uncertainty about the magnitude and speed with which Trump’s policy proposals might be implemented. And there’s some optimism that they’d be met with measures to stimulate economic growth in Europe.

Why is the 1:1 level important? 

Hitting parity is psychologically significant for investors and policymakers and could spur a period of volatility for the euro as billions in options bets are likely to be linked to it. The risk that a country could tumble out of the euro remains alive, if remote, and a fall to parity could embolden populist politicians who oppose the single currency. Already Germany’s right-wing AfD party is planning an election campaign advocating the country’s exit from the EU and the euro.  

How would a weaker euro affect the European economy?

Policymakers often welcome a weaker currency as a means to stimulate economic growth because it makes exports more competitive — though that positive impact may be diminished if the US imposes tariffs on those goods. A weaker euro also makes it more expensive to import raw materials and could reignite price pressures. That would prove to be a headache for the European Central Bank, which had been hoping post-pandemic inflation was finally under control. ECB executive board member Isabel Schnabel warned that a “material depreciation” of the euro’s exchange rate would have an impact on inflation. For consumers, a weaker euro makes it more costly to buy imported goods and vacation outside of the eurozone. Conversely, the tourism sector may benefit from an influx of visitors from the US. 

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Could the ECB intervene to support the euro? 

The exchange rate is not a policy target for the ECB, and there is no set level of euro strength or weakness that policymakers would react to. They do take exchange rate movements into account when they set interest rates, but direct intervention to support the euro is extremely rare. So far, the central bank has only intervened in foreign exchange markets a couple of times: to support the euro in 2000 and as part of a coordinated effort by the G-7, an informal group of advanced democracies, to weaken the Japanese yen in 2011.  

• Past explainers on why the US Dollar dominates the global economy, why the euro hit parity in 2022, why some countries want to join the common currency, and the euro’s flaws.
• Bloomberg Opinion’s Marcus Ashworth argues that the euro is doomed to drop to parity with the dollar again.
• Bloomberg Intelligence analyzes the potential impact of a weakening euro on ECB rate policy.

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