Understand what the consequences are when the euro falls below the dollar

The European currency fell below the dollar par for the second time, reaching its lowest price in nearly 20 years at $0.9901. What are the direct consequences of this devaluation of the euro?

How to explain the devaluation?

It is due to the strength of the dollar, supported by the monetary policy of the Fed (Federal Reserve, the central bank of the United States).

Unlike the ECB (European Central Bank), the Fed quickly started raising its interest rates to fight inflation. These high interest rates make it more profitable to own dollars, which attracts investors and further appreciates the currency.

For its part, the ECB raised its rates moderately, but its long-term policy is unknown and this uncertainty weighs against the euro.

“The ECB is in a difficult situation. It cannot suddenly raise its interest rates, as it could provoke a sovereign debt crisis in the most indebted countries in the euro zone”, explains Eric Dor, director of Economic Studies at the IESEG School of Management. “The Fed doesn’t have that problem.”

Consequently, the rate difference plays “very much in favor of the dollar”. In addition, the Ukrainian War and Europe’s dependence on Russian hydrocarbons reinforce the growing uncertainty suffered by the eurozone economy, the expert added.

Effects on inflation and purchasing power

Almost half of the products imported into the euro zone are invoiced in dollars and less than 40% in euros, according to Eurostat.

This is the case for oil and gas and many commodities whose prices soared in the context of the Ukrainian War.

But with the devaluation of the European currency, more euros are needed to buy imported products in dollars, which contributes to accelerating inflation. And if this price increase is not accompanied by an increase in wages, there is a loss of purchasing power for families.

Second, the devaluation of the euro against the dollar will put a brake on European tourism, especially in the United States. On the other hand, American tourists come out ahead on their trips to Europe: theoretically they can consume more for the same amount of dollars.

Effects on companies

The effect of the euro’s fall varies according to companies’ dependence on foreign trade and energy.

“Companies that export outside the euro zone benefit from the devaluation of the euro as their prices are more competitive [uma vez convertidos em dólares]while companies that import are penalized”, summarizes Philippe Mutricy, director of studies at the public bank Bpifrance.

On the other hand, for companies dependent on commodities and energy, and that export little, such as local artisans, costs soar.

The big winner of the euro’s fall is the European manufacturing industry that exports products abroad, such as the aeronautics, automotive, luxury or chemical sectors.

Effect on growth and debt

In theory, the euro’s fall benefits European export sectors abroad, especially Germany, whose economy is largely based on trade and sales abroad.

For European countries’ debt repayment, the impact is less evident. For example, for states that issued bonds in dollars, a devaluation of the euro against the dollar increases the cost of this repayment.