The euro falling below parity with the dollar, as seems increasingly likely, would mark a symbolic threshold for watchers of the single currency’s history. It hasn’t been that low since 2002. For European Central Bank President Christine Lagarde however, the weak currency is both an implicit criticism of the central bank’s monetary policy, and a further thorn in its side.
The euro’s current weakness, which saw the single currency hover just above 1 dollar on Tuesday morning, can be seen first as a sign of the greenback’s strength. The U.S. Federal Reserve has hiked its policy rates aggressively, and the administration of President Joe Biden embarked last year on massive fiscal stimulus. Compared to a trade-weighted basket of other currencies, the euro is only down 4.5% over the last year, against an 18% fall against the dollar.
But the dollar’s relative strength is also partly of the ECB’s making. By keeping its key policy rate low – at minus 0.5% since September 2019, before the pandemic – the ECB has encouraged investors to dump euro assets in favour of higher dollar yields. That’s in spite of the fact that inflation was shooting up – at an expected 6.8% this year.Whatever the party line that it doesn’t target exchange rates, the ECB cannot ignore the current weakness.
The euro’s weakness will therefore likely fuel ECB divisions on the desirable pace of rate increases, and whether they should start with a 0.25% hike on July 21, or something more aggressive. There is an economic silver lining: a weak euro favours exporters by making their goods more competitive on world markets. But with the global economy headed towards a slowdown and supply chain problems still gumming up trade, that small advantage is unlikely to make the ECB’s life easier.
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