Looking for the Euro’s Floor
How low can the euro go?
The currency has taken a considerable hammering recently, especially relative to the dollar against which it’s close to a 12-year low. A year ago, the euro bought a shade under $1.40. It started this year at $1.21. By Tuesday it was trying to break below $1.07. By Wednesday, $1.065.
The fall hinges on divergent central bank policies on either side of the Atlantic. The European Central Bank unveiled a massive bond purchase program in January–more than €1.1 trillion ($1.2 trillion) of asset purchases in €60 billion monthly instalments until at least September 2016, a monetary expansion that’s equivalent to around 10% of eurozone GDP. By contrast, the Federal Reserve is expected to start raising rates from mid-year in response to shrinking excess capacity in the economy and fast-rising employment.
Which suggests the euro can keep falling for some time to come. Dollar-euro parity seems to be just around the corner, according to investment banking forecasters. Sub-parity is also being eyed.
But at some point the euro’s declines will put eurozone exporters into such a strong position that flows from investors out of the euro into the dollar seeking higher yields will be offset by flows from foreign consumers into the euro seeking to buy eurozone goods.
Indeed, the latest Economist Big Mac index–which estimates how fairly currencies are priced relative to each other based on comparing the price of a McDonald’s Big Mac hamburger in the respective countries (it might sound frivolous but it’s taken seriously by economists)–suggested the euro was already more than 10% undervalued relative to the dollar back in January. It’s lost further ground since.
Now, this has as much to do with a strong dollar as with a weak euro.
- The Wall Street Journal
The euro’s lost less ground against other currencies. It’s broadly at fair value against the pound and was overvalued against the yen–the Bank of Japan has been running an aggressive policy to weaken its currency for longer.
Over the past year, the euro’s fallen 12% against a basket of currencies weighted by the euro area’s foreign trade, about half the pace of its decline against the dollar. Since the start of this year it’s down 8% on a trade-weighted basis against that basket, versus a fall of 12% against the dollar alone....MORE
