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It should have been a day of celebration, as the euro welcomed Croatia as its 20th country.
But as finance ministers backed their new club member, the single currency slipped into a less welcome milestone: parity with the U.S. dollar.
Analysts are now wondering how far the euro could fall, amid concerns that the rapid fall in the currency this year could worsen the cost of living of misery for hundreds of millions of Europeans.
Ultimately, as rising energy costs and inflation tighten the standard of living, there could be a political price to pay.
“The fall of the euro has much more room to pass,” Robin Brooks, chief economist at the Institute of International Finance, tweeted on Sunday. “We’re just getting started.”
On Tuesday, the euro briefly reached parity against the U.S. dollar for the first time in 20 years. The last time the euro was worth less than the dollar was in 2002, when the euro cash was in its infancy and is only shared by 12 member states.
The single currency has lost more than 10 percent of its value against the green dollar since the beginning of the year. It was a rapid fall, driven in part by worsening growth prospects in the eurozone thanks to Russia’s invasion of Ukraine and stronger demand for the dollar as a safe haven currency.
As always, not everyone will see it as bad news. There are advantages to the fall of the currency, that is, exports become cheaper and more attractive. But European Economic Commissioner Paolo Gentiloni warned it would be “a mistake” to see the euro fall in these terms.
“Of course, it is boosting export capacity, but we also need to look at the downside of this currency,” he said at a news conference on Monday.
A weak euro makes imports more expensive, which increases inflationary pressures.
One of the political leaders who has warned of this risk is Francois Villeroy de Galhau, a member of the Governing Council of the ECB. Earlier this year, he warned that the central bank “will carefully follow the evolution of the effective exchange rate, as a major driver of imported inflation.”
“Too weak a euro would go against our goal of price stability,” he added.
An ECB document released in 2020 cited models that estimated that a 1 per cent depreciation of the euro against a basket of currencies could add up to 0.11 percentage points to inflation in a year, and 0 , 25 percentage points in three years.
No funds yet?
Analysts warn that the euro may not have reached its minimum level given the persistent risks that a Russian gas cut could throw the region into a deep recession.
Some suggested that one euro could go down to 90 US cents in the bleak but not impossible event if Russia did not restart the Nord Stream 1 pipeline.
In turn, this scenario could significantly limit the ECB’s ability to raise interest rates, which it has yet to do. It is expected to raise benchmark rates by 25 basis points on July 21, when it holds its next political meeting, and may announce a larger rise in September.
The U.S. Federal Reserve, on the other hand, has advanced, overburdening the dollar with higher interest rate hikes.
“It is still perceived that the Fed has more room to raise rates in the future, also from the strong US employment report in June,” UniCredit currency strategist Roberto Mialich said in a note. research. “On the other hand, other central banks, such as the ECB and the [Bank of England]they could be forced to be more cautious, given the more direct exposure their respective economies have to the gas and energy crisis. “
At the same time, the dollar is benefiting from safe haven flows, with investors rushing to U.S. government bonds as hedging against economic and political uncertainty.
If the euro continues to fall, “without a doubt [the ECB] will be quite concerned about the measure, especially if it becomes a “sell the eurozone” mentality, ”said ING economist Chris Turner. it is a pro-cyclical currency, the ECB’s hands may be tied to its ability to threaten more aggressive rate hikes in defense of the euro. “
Concern over the euro came on the day EU finance ministers gave final approval to Croatia’s accession to the eurozone, which allowed it to adopt the single currency from of January 2023.
“The fact that Croatia becomes the 20th member of the European Monetary Union area is also a clear sign that European integration continues despite all the challenges we face,” said Zdravko Marić, Croatia’s outgoing finance minister.
This Tuesday’s proceedings complete the years-long accession procedure, which obliges countries to meet a number of criteria such as price stability, exchange rates and interest rates, as well as budgetary discipline and prohibition. of monetary financing.
Croatia will also win a seat on the governing board of the European Central Bank, as an observer from September and as a full member in January.
Welcoming the group to Croatia, ECB President Christine Lagarde said membership requires commitment and respect for the rules, adding: “It’s a wonderful club to be a member of.”
Tim Ross contributed to the report.