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Why is the euro falling against the dollar?

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The euro has been losing ground against the dollar since the beginning of the year, when it was hovering around $1.13, to match the U.S. dollar

The euro and the U.S. dollar are exchanging at a 1-to-1 rate for the first time in nearly two decades, when the European currency was in its infancy.

The euro has been losing ground against the dollar since the start of the year, when it hovered around $1.13, amid an aggressive anti-inflation campaign by the U.S. Federal Reserve, along with broader global disruptions triggered by Russia’s invasion of Ukraine. They reached parity on Wednesday morning and the dollar was as high as €0.9999 on Thursday.

Why is the euro falling against the dollar?

In the United States, the Federal Reserve has raised interest rates aggressively, pushing up Treasury yields and making the dollar more attractive to investors than the euro. The U.S. central bank has raised rates three times in 2022 and has signaled that it plans four more hikes as part of its strategy to control inflation.

The European Central Bank is also expected to raise rates to bring inflation back to the 2% target, but at a slower pace than the U.S.: The European Central Bank has targeted a 0.25 percentage point rate hike for July, while the Federal Reserve is expected to raise 0.75 percentage points, as it did in June.

The dollar is seen as a safe haven, and has gained strength as investors maneuver through an uncertain economic playing field in Europe and elsewhere.

Another thing to note is that virtually all currencies are falling against the dollar, for example sterling and the yen have also fallen this year, partly because more aggressive interest rate hikes in the U.S. have increased the dollar’s appeal and also because fears of a global recession have caused investors to flock to the dollar as a safe haven.

What does parity mean for the euro?

It doesn’t really mean anything. Despite the concerns, some analysts described the euro-dollar parity as a “psychological” milestone that would not necessarily be a turning point for the currency, which was already a long way from its 2008 peak near $1.60.

Even so, it is to be expected that Europe will no longer get results just by sending some reassuring messages to the market, so the pressure on the ECB and the continent’s policymakers will be “forced to respond” with facts, i.e. interest rate hikes, to the fears of depreciation.

What can the ECB do?

To support the euro, the ECB could signal more aggressive tightening, including a 50 basis point rate hike in September, and further moves in October and December. If the currency continues to depreciate, the ECB could buy Euros to push up its price as it did in 2000 when it intervened when it was weakest (then at 0.86 Euros to the dollar) but that will run into frontal opposition from some European countries with out-of-control public deficits and unpayable public debt.

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