PROPONENTS of a strong euro need to be careful what they wish for. If the common currency strengthens much more, it’s going to choke off the euro area’s economic recovery – anaemic though it’s likely to be – before it can get going.
If experience over the last decade holds true, a too-strong euro is the last thing the euro area needs. Former European Central Bank president Mario Draghi always tried to avoid mentioning currency strength but was forced to address it in 2014, 2017 and again in 2018. However, it’s his most recent foreboding intervention on the “Future of European Competitiveness” that’s most relevant now.
There’s been a lot of noise about huge European Union (EU) spending on defense and infrastructure, led by Germany, and expectations – notably from European Central Bank (ECB) president Christine Lagarde – that the common currency will capitalise on the weakening dollar.
As with much of the commentary on the dollar, many of the bullish euro assumptions confuse usage of a currency with the separate concept of a currency pair’s relative value to each other. There is little evidence that the euro is becoming the international currency of business outside its sphere of influence. Gold has usurped the euro, according to the ECB’s annual assessment as the second most important component of global central bank reserves. According to a World Gold Council survey, that trend is likely to persist without threatening the dollar’s top slot in global usage or reserve holdings.
True, the euro has gained 13 per cent to the dollar this year, but perhaps more reflective is its 3 per cent appreciation gain against sterling: The ECB has cut interest rates twice as fast as both the Federal Reserve and Bank of England over the past year, yet it’s having next to no effect on its currency’s valuation. So while the euro is currently set fair, it will require the fiscal cavalry to really boost its domestic demand. Of course, in relative terms, it also needs other economies not to perform as strongly. That’s a big ask.
The euro area may well be still the largest collective single market, but its economic momentum has always been driven by manufacturing exports. Which explains why it’s currently mired in tariff talks with the Trump administration. Germany’s 250 billion-euro (S$375.3 billion) current-account surplus is the biggest globally, even usurping Japan last year. What used to be a key EU strength is now an Achilles heel. A stronger euro only makes it harder going to sustain export volumes.
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The jawboning may have already begun. ECB vice-president Luis de Guindos told Bloomberg TV on Tuesday (Jul 1) that the euro’s ascent above US$1.20 “would be much more complicated, but US$1.20 is perfectly acceptable”.
On a trade-weighted basis, the euro has never been stronger, according to the ECB’s own 41-currency measure. Dollar weakness is still the most important factor, as one-fifth of EU exports head stateside, but relative value to the Chinese yuan is nearly as important with bilateral trade of 740 billion euros in 2023.
Bloomberg Intelligence chief G10 currency strategist Audrey Childe-Freeman warns that the ECB will be concerned the euro’s gains will accelerate if the US economy weakens. This faster pace of the euro’s ascent may prompt the ECB to cut rates further, even below its preferred neutral area of around 2 per cent, where the deposit rate now is. In fairness, there will be opposing beneficial effects such as lower import costs, which could over time reduce household bills and boost disposable income and consumption. However, with euro area inflation below the ECB’s 2 per cent inflation target, the risks of disinflation might be the bigger concern. French June inflation was 0.8 per cent annually.
A strong, competitive economy can take a firmer currency in its stride, as the deutsche mark prior to the euro’s adoption attested. But a struggling euro economy growing at barely 1 per cent is a long way from that. The ECB has halved its official rate in the last year for a reason. Delivery of all the promised fiscal splurge, and sooner rather than later, is fundamental to the euro’s continued ascent. Standing for itself on defense is critical, but heeding Draghi’s plea to boost competitiveness is also crucial. Seeing will be believing for the euro to assert itself on the world stage, and that means getting its domestic act together first. BLOOMBERG
