When Will the Dollar Overtake the Euro?

Analysts have described 2022 as “the worst year in the euro’s history”. However, the euro’s significance has been declining over the past two decades. Its share of global official holdings of foreign exchange reserves was 20.6% at the end of 2021, down from approximately 25% in 2003.

In addition, the euro has lost 16% of its value against the dollar over the past year and is trading at its lowest since December 2002. The currency is currently 20% lower than its average value since 1999.

In contrast, the U.S. dollar has strengthened against the euro recently, appreciating by around 15%. The two currencies are trading close to parity for the first time since the early 2000s. Several factors, including the Fed’s more aggressive tightening cycle, safe-haven dollar demand and concerns over the European economy due to energy shortages have been key drivers.

However, the question is: Will the dollar overtake the euro? Let’s look at the factors influencing this currency competition in more detail and consider potential outcomes.

Depreciation of euro in 2022

One of the key reasons behind the euro’s depreciation against the dollar in 2022 has been the widening gap in monetary policy between the Federal Reserve and the ECB. The Federal Reserve started hiking interest rates in March 2022, followed by further, faster increases. In contrast, the ECB adopted a more cautious approach with its first rate hike announcement later in July 2022.

However, widening interest rate differentials are not the only factor contributing to the euro’s decline against the dollar. The ongoing conflict between Russia and Ukraine has had significant negative effects on the Eurozone’s macro fundamentals, affecting external accounts and eroding the confidence of households, businesses, and foreign investors.

Consumer confidence within the Eurozone has decreased, with the consumer confidence indicator falling to -16.1 in January 2024, a fall of 0.9 on December’s figure.

Another major factor that contributed to the euro’s decline below parity with the dollar is increasing natural gas prices in Europe. In particular, the wholesale gas benchmark in Europe (Dutch TTF) is currently eight times higher than US domestic natural gas prices. This places European companies and consumers at a big competitive disadvantage compared to their American counterparts.

Fears of an economic downturn in Europe

Although the labour market in Europe remains strong, with an unemployment rate at historic lows of 6.4%, inflation is higher than in the United States, especially if the prices of food, services, and non-energy industrial goods are taken into account. According to Juan Martínez (an expert on the political situation and world economy at IE University), Europe will not be able to begin its recovery until these prices decrease to normal levels.

In addition, the price of a barrel of Brent crude oil, which surged to $90, threatens to cause further inflationary increases. Under this framework, experts and investors are becoming more concerned about the possibility of a recession. They estimate that the ECB will pause before resuming with the increases.

More competitive European exports

Europe pays for the energy products it imports in dollars, so the most dependent countries, like Spain, are affected by price increases as they pay more for the gas and oil they need. Because this increase is passed on to consumers via energy prices, consumers also lose out.

It’s not all bad news for the euro, though. As a result of the currency devaluation, European exports are now more competitive on the foreign market because they are sold for less without affecting producers’ margins. Also, European companies can increase their cash flow by repatriating profits or receiving dividends from their foreign subsidiaries.

Additionally, countries that use the euro become more attractive to non-EU travellers as it makes their stay cheaper and they receive more euros when they exchange their local currencies.

Euro challenges and economic outlook

The euro faces a challenging environment in 2024, marked by both political shifts and economic uncertainties. Key events include parliamentary and presidential elections across several Eurozone countries, while challenges include global conflicts, fiscal tightening and inflation concerns.

Following two consecutive years of depreciation, the euro rebounded in 2023, with a 3% gain against the dollar. The single currency faces a landscape rife with economic and political events, as well as challenges that could influence its course in the months ahead.

Political elections and changing dynamics

In 2024, there will be many important political events across the Eurozone. Belgium, Austria, Croatia, Lithuania, Slovakia, and Portugal are all getting ready for major parliamentary or presidential elections. However, the spotlight is fixed on the upcoming European Parliament elections scheduled between June 6 and 9, 2024.

The renewal of 705 Members of the European Parliament is expected to bring about changes at the highest levels of the European Commission and the European Council, with the introduction of new policy initiatives that could affect the euro.

Global conflicts to fiscal tightening

The Eurozone faces many challenges due to ongoing international conflicts in regions such as Ukraine and the Israel-Gaza strip. Domestically, the bloc must also cope with economic trials, particularly concerning the EU’s budget and the important green transition.

Fiscal policies within member states are expected to tighten in 2024. The European Commission expects a reduction in energy support measures, which will greatly affect the fiscal stance.

Germany’s “debt brake” will be critical, especially after the German Constitutional Court declared a large part of the government’s funding plan for climate and energy programs unlawful in November 2023. This decision resulted in a €60 billion shortfall in the nation’s public finances.

Slowing inflation and rate cuts on the horizon

On the economic front, following a strong post-pandemic recovery led by the services sector, growth has slowed due to rising living costs, weak external demand, and tighter monetary policy. Inflation is expected to continue declining, though the phasing out may potentially slow down the decline in price pressures.

In terms of monetary policy, the European Central Bank (ECB) left its key interest rates unchanged in December, indicating the possible end of its tightening cycle.

However, in contrast to Federal Reserve Chair Jerome Powell, ECB President Christine Lagarde emphasised the importance of remaining vigilant, stating that now is not the time to “lower our guard” on interest rates. The market anticipates approximately seven 25-basis-point rate cuts by the ECB in 2024.

Euro-dollar projections

ING Group is bullish on the euro, expecting it to rise to 1.15 against the dollar due to a slowdown in the US economy leading to Fed interest rate cuts. However, it recognises that weak growth in the eurozone could lead the ECB to lower rates alongside the Fed, limiting the euro’s appreciation.

According to the Bank of America, the EUR/USD will reach 1.15 by the end of 2024.  The currency pair is expected to strengthen due to Fed rate cuts, despite expectations of weak Eurozone growth.

However, US investment bank Citigroup expects continued economic weakness in Europe, driven by a slowdown in consumer spending and reduced fiscal stimulus. It maintains a forecast of 1.02 for the EUR/USD pair in the next 6–12 months.

Considerações finais

While the euro’s recent challenges and the dollar’s relative strength have increased speculation about the dollar potentially overtaking the euro, the situation is still complex and uncertain. The outcome will depend on many factors, including economic policies, geopolitical developments, and market dynamics.

A key role will be played by the eurozone’s ability to address its economic challenges, handle political uncertainties, and implement effective monetary policies. Similarly, the course of the US economy, the Federal Reserve’s decisions regarding interest rates, and global market sentiment towards the dollar will influence the outcome. It will take careful monitoring of these factors in the coming months and years to determine whether the dollar will overtake the euro.

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