What is the economic impact of the dollar reaching parity with the euro?

First modification: 07/08/2022 – 04:52

An unstoppable rise. The US dollar has risen so much that, for the first time in 20 years, its value is almost equal to that of the euro. But this increase could hurt US companies, because their products become more expensive for foreign buyers.

One consequence is that US exports may weaken, and as a result, so would the already sluggish US economy.

Although as every currency has two sides, a stronger dollar provides a small relief from inflation because the wide variety of goods that are imported into the United States such as vehicles, computers, toys and medical equipment become cheaper. This is good news for those who want to do tourism in Europe.

The dollar index, which measures the value of the US currency against the six major foreign currencies, has soared nearly 12% this year to hit a two-decade high.

Why does the dollar continue to rise?

The rise of the dollar is the product of the increase in interest rates by the United States Federal Reserve, the Fed, whose increases have been more aggressive than the central banks of other countries, in their effort to cool the highest inflation of United States in four decades.

Rate hikes cause U.S. Treasury yields to rise, attracting investors seeking higher yields than they can get elsewhere in the world. This demand for dollar-denominated securities, in turn, drives the value of the dollar.

Rubeela Farooqi of ‘High Frequency Economics’ states that, despite concerns about a possible recession in the United States, “the US economy is in a stronger position than the European one”.

The euro has fallen largely on growing fears that the 19 countries that use the common currency will slip into recession. The war in Ukraine sent oil and gas prices skyrocketing, punishing European consumers and businesses.

Also reduced supplies of natural gas by Russia have led to higher prices and raised fears of a supply cut that could force governments to ration energy to industry to save on homes, schools and hospitals.

Europe says Moscow’s move is an effort to blackmail them for backing Ukraine and in retaliation for Western sanctions following the Russian invasion. With the fall of the euro, European governments will buy more expensive energy because most transactions are made in the American currency.

US with more room to maneuver

“This war is a ‘body blow’ to Europe,” Robin Brooks, chief economist at the Institute of International Finance banking group, tweeted this week. “It undermines Germany’s growth model, which is based on cheap Russian energy. Europe is facing a seismic shift, and (the) euro has to fall to reflect it.”

Analysts at ‘UniCredit’ say fear of a global recession was the main driver of currency markets “amid widespread sentiment that the Federal Reserve may ultimately have more opportunity than many other central banks” to raise rates.

The report details the dollar’s role as a recognized safe haven around the world, in light of recent financial market turmoil, as another factor driving demand for the dollar.

with AP