Euro at Parity with US Dollar – why should we in the UK care?

An ever-strengthening U.S. dollar has achieved parity with the Euro. This is the first time the US dollar has reached parity since the Euro was in its infancy over 20 years ago.

Why should we in the UK care about a strengthening US dollar or a depreciating Euro?

Background

The invasion of Ukraine sent shock waves through both the global food and energy markets – resulting in significant price hikes.

Food and energy are two significant basic needs for consumers. As a consequence of the requirement for many economies to import food and/or energy, those commodity price rises have fanned domestic inflation.

Also, with many global commodity prices set in US dollars, the strengthening US dollar has added to those importation costs and that inflationary pressure.

The USA is both a producer of grain and fossil fuels so, arguably, better able to ride out any turmoil in commodity markets. Having said that, inflation is currently a major issue in the USA – they way it is in many economies across the globe.

US Dollar Strength

Since World War Two, the US dollar has been considered a safe haven in times of global crises and, generally, there is a flight of capital to safe havens when global economic shocks occur.

Any flight of capital (from the Euro, Sterling etc.) will strengthen the US dollar and weaken the other currencies.

Also, the U.S. Federal Reserve has been relatively more aggressive in raising interest rates, thereby increasing yields on US Treasury Bonds, and making the US dollar even more attractive to investors.

All of that has resulted in a significant strengthening of the US dollar, particularly in the past few months.

It is not just the Euro that is under pressure

The Euro has been depreciating against the US dollar for over a year now. It is 15% down in the past 12 months – but 11% of that loss has occurred since the Russian invasion of Ukraine.

The Euro is not alone. Sterling is also down against the US dollar by 15% in the past year and 11% since the invasion of Ukraine.

Against the Japanese Yen, the US dollar has appreciated 26% in the past year with 21% of that gain since the invasion of Ukraine.

Even against that other traditionally safe haven currency, the Swiss Franc, the US dollar has appreciated over 6% in the past 12 months – almost all of that gain since the invasion of Ukraine.

Despite the recent media headlines, the Euro is not alone in being under pressure – albeit parity with the US dollar is an added psychological factor for the Euro.

Interestingly, the exchange rate for Sterling v Euro has not moved much in the past 12 months – it was 1.17 a year ago and is just above 1.18 now (down slightly from 1.19 at the time of the invasion of Ukraine). As such, the UK cannot ignore what is happening to the Euro.

What does this mean for businesses and consumers?

Movements in global currencies can have a major impact on businesses that sell their products abroad or depend on imported raw materials for inputs into their own finished goods.

Higher importation costs (plus a strong US dollar) put pressure on business operating margins that can only be repaired by raising selling prices. Factory prices rises, of course, lead to inflationary pressures. Factory price rises can also dampen consumer demand which in turn affects businesses cash generation and profitability.

Domestically, inflationary pressure is often tackled by raising interest rates but that also hits consumers through higher mortgage servicing costs.

Those significant cost of living increases lead to wage demands – we are seeing those and a greater incidence of strikes in support of higher wages.

As employee costs are another significant input for businesses, especially in the UK where our level of automation is below that of other major competitor economies, any wage increases will add to inflationary pressure.

In turn, that inflationary pressure would result in further factory price rises, put additional stress on consumer demand and, ultimately, lead to an increase in unemployment. That is a vicious cycle that can easily result in recession and, even, stagnation.

To answer the question raised at the start of this article – yes, we should care about the weakening Euro and the strengthening US dollar.

Written by Alan Wilson