Euphoria. It is a victory that Pirro would have been proud of. The euro is appreciating against the dollar even though traders expect the bloc’s interest rates to fall more than those in the US, which in theory should lead to a stronger dollar. There are good reasons for these measures, but a strong currency will further strain the eurozone economy.
The euro has risen almost 3% against the dollar this month and on Wednesday hit $1.117, the highest level in more than a year. The move contradicts the idea that interest rate differentials drive currencies. Traders are betting euro zone rates will hit 2.3% by July 2025 from 3.75% now, while U.S. rates are expected to only fall to 3.4% from around 5.4% now, according to derivatives prices compiled by LSEG. In theory, that gap should boost demand for U.S. assets and strengthen its currency.
In practice, several factors are pushing the rate down. The first is the market’s fear that the US Federal Reserve will sanction bigger and faster rate cuts if the domestic economy and the labour market worsen. A turn for the worseThe second is political uncertainty. Republican presidential candidate Donald Trump has… saying He wants a weaker dollar if he wins the November election.
The third concern is Washington’s debt burden. Congress Budget Office Forecasts that federal borrowing will exceed 122% of GDP in 2034, compared with less than 100% today. And finally, the dollar may continue to suffer from the after-effects of this month’s crisis. unrolling of the “carry trade,” a strategy that increased demand for dollars because investors borrowed Japanese yen to buy dollar-denominated assets.
However, the rise of the euro is a headache for the president of the European Central Bank, Christine Lagarde. A strong currency increases the prices of exports, making them less competitive. This is a problem because the sale of goods and services abroad represents a significant increase in the price of exports. almost a third of eurozone GDP. In the first quarter of 2024, exports increase by 1.3% in the previous three months, offsetting slow growth in other areas.
Lagarde could cut rates even faster to counter the effect, but that would be risky as long as inflation remains above the ECB’s 2% target. Or she could wait for the dollar to regain its strength, for example if a global shock triggers a flight to the safe haven of Treasuries, or if the severity of interest rate differentials finally takes hold.
Until then, the eurozone economy will have to hope that the ECB can snatch a monetary defeat from the jaws of a Pyrrhic victory.
Context news
On August 21, the euro hit its highest level against the US dollar in more than a year. The single European currency hit $1.1173, its highest level since July 2023, as traders focused on the possibility of interest rate cuts in the United States. The euro is now the second best-performing currency against the dollar this year, after the pound.
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