Euro falls below parity with the dollar. What is the impact?

The euro has fallen below par with the dollar, plunges to its lowest level in 20 years and ends a one-to-one exchange rate with the US currency.

It is a psychological barrier in the markets. But psychology is important, and the euro’s decline underscores the doom in the 19 European countries that use the currency as they grapple with an energy crisis triggered by Russia’s war in Ukraine.

Here’s why the euro is shifting and what impact it could have:

WHAT DO EURO AND DOLLAR PARITY MEAN?

It means that the European and American currencies are worth the same amount. While changing constantly, the euro has fallen just below $1 this week.

A currency’s exchange rate can be a judgment on economic prospects, and Europe’s is fading. Expectations that the economy would recover after the COVID-19 pandemic turned the corner has been replaced by recession forecasts.

Above all, high energy prices and record inflation are to blame. Europe is much more dependent on Russian oil and natural gas than the US to keep industry going and generate electricity. Fears that the war in Ukraine will lead to a loss of Russian oil in world markets has pushed up oil prices. And Russia has cut natural gas supplies to the European Union, which EU leaders described as retaliation for sanctions and arms supplies to Ukraine.

Energy prices pushed inflation in the eurozone to a record 8.9% in July, making everything from groceries to utility bills more expensive. They have also raised fears that governments will have to ration natural gas for industries such as steel, glassmaking and agriculture if Russia further cuts or completely shuts off gas taps.

The sense of doom increased as Russia cut flows through the Nord Stream 1 pipeline to Germany to 20% capacity and said it would shut down for three days next week for “routine maintenance” at a compressor station.

Natural gas prices on the European TTF benchmark have risen to record highs amid dwindling inventories, fears of further shutdowns and strong demand.

“If you think the euro is cheap at parity, think again,” tweeted Robin Brooks, chief economist at the banking trading group Institute of International Finance. “German industry no longer has access to cheap Russian energy. and thus its competitive advantage.”

“A global recession is coming,” he said in a second tweet.

WHEN WAS THE LAST TIME THE EURO WAS EQUAL TO THE DOLLAR?

The euro was last valued below $1 on July 15, 2002.

The European currency hit its all-time high of $1.18 shortly after launching on January 1, 1999, but then began a long decline, falling below $1 in February 2000 and reaching a record low of 82.30 cents in October 2000. rose above parity in 2002 as major trade deficits and accounting scandals on Wall Street weighed on the dollar.

Then, as now, what appears to be a euro story is in many ways a dollar story. That’s because the US dollar is still the world’s dominant currency for trade and central bank reserves. And the dollar has hit a 20-year high against the currencies of its major trading partners, not just the euro.

The dollar also benefits from its status as a safe haven for investors in times of uncertainty.

WHY DOES THE EURO FALL?

Many analysts attribute the euro’s decline to expectations of rapid rate hikes by the US Federal Reserve to fight inflation at its 40-year high.

As the Fed raises interest rates, so do the rates on interest-bearing investments. If the Fed raises interest rates more than the European Central Bank, higher interest yields will attract investor money from euros to dollar investments. Those investors will have to sell euros and buy dollars to buy those positions. That drives the euro down and the dollar up.

Last month, the ECB raised interest rates by half a percentage point more than expected for the first time in 11 years. Another increase is expected to be added in September. But if the economy slides into recession, it could halt the ECB’s series of rate hikes.

Meanwhile, the US economy looks more robust, meaning the Fed could continue to tighten – and widen the interest rate gap.

WHO WINS?

American tourists in Europe will find cheaper hotel and restaurant bills and entrance tickets. The weaker euro could make European exports more competitive in the United States. The US and the EU are important trading partners, so the exchange rate shift will be noticed.

In the US, a stronger dollar means lower prices for imported goods — from cars and computers to toys and medical equipment — which could help moderate inflation.

WHO LOSE?

American companies that do a lot of business in Europe will see the revenues of those companies shrink when and if they bring that revenue back to the US. If revenues in euros remain in Europe to cover costs, the exchange rate becomes less of an issue.

A major concern for the US is that a stronger dollar makes US-made products more expensive in overseas markets, widening the trade deficit and decreasing economic output, while giving foreign products a price advantage in the United States.

A weaker euro could be a headache for the European Central Bank as it could mean higher prices for imported goods, especially oil, which is priced in dollars. The ECB is already being pulled in several directions: it is raising interest rates, the quintessential medicine for inflation, but higher rates could also slow economic growth.