What happens when the euro goes up?

Friday, 15 september 2017 | Redacción CEU

The European Central Bank faces a new challenge, the euro appreciation. What at first glance seems a good sign, the economy recovers from the post-crisis malaise that has been subjected to during the last years, it is also a difficult defiance. The European unit currency strengthening can change the course of the current economic scenario. How does the European bank confront this situation? What consequences brings the appreciation of this currency?

Currency is our value pattern. With it we make exchanges, buy goods, carry out transactions, accumulate wealth and also incur debts. It has cancelling power and represents our purchasing power. The euro not only reflects our national economy state, it sets the course of macroeconomic policies. Its vitality is a recovery symbol, also the sign of the beginning of a change. The finance future will depend, to a large extent, on how its growth is managed.

Why does the euro keep rising?

Before analyzing the consequences that the euro robustness can bring, it is convenient to review how we have got to this situation and what is the point at where we are. At the present time, our euro reaches the highest level against the dollar since 2015. The past ECB press conference of President Mario Draghi, where prudence reigned, only served to underpin the euro rise and even serve it as a catalyst. But, what are the main reasons that have led to the currency appreciation?

The euro area economy recovery

Calm comes after the storm. The accommodative monetary policy has marked the European agenda in recent years. Its results are tangible now, with the first symptoms of recovery. In the second quarter of 2017, the real eurozone GDP grew 0.6%, the first quarter was 0.5%. The projections point to a broad and sustained growth in the future.

The dollar and pound sterling weakness

Low expectations on a tax drop, the Hurricane Harvey consequences on the rising oil prices, the lack of support to renegotiate the US debt ceiling, Irma's arrival in Florida, the escalating geopolitical tension with North Korea.,... The dollar is not at its best. In turn, Brexit and the pound depreciation continue forming an unbreakable binomial. The uncertainty about the UK departure from the European Union and the weakness of the Theresa May government have led to this currency deterioration.

The Spanish and French push

France has experienced the largest economic growth period since 2011. In Spain, the economy recovers and, since 2015, it grows to a faster pace. These good results also contribute to the euro appreciation.

When does the tapering arrive?

It is not easy to give up the economic policies used until now in the eurozone. Prudence prevails. It is not surprising, because we enter into an unexplored territory. In crisis times, central banks decided to adopt exceptional measures, like providing liquidity to banks, lowering interest rates, buying assets and public debt,... Nowadays, the time has come to abandon these extraordinary rules in Europe. Although the economic recovery in the euro area has never been as strong as it is now, leaving these regulations behind implies some dangers.

Perhaps that is why the European Central Bank has postponed the announcement of the economic stimulus withdrawal, known as tapering or the QE progressive retreat, for next October. There is no reason to fully step on the brake . In the last press conference, the ECB President, Mario Draghi, remained cautious. The Italian economist does not want to show the cards of the strategy that will be adopted when containing the euro growth. However, the currency strength could hinder the gradual stimulus withdrawal in the eurozone.

The Draghi's dilemma

The European unit currency growth is now one of the biggest challenges that the eurozone is facing. Since 2016, the currency has been revalued 12% against the dollar and 6% against the currencies of the main countries trading with the eurozone. An increase of 10% in the euro is estimated to lead to the destruction between 7% and 8% of the business incomes of countries that are using this currency. Nevertheless, the effects are not revealed immediately. On the other hand, the announcement of the change of direction about economic policies can influence abruptly in the investors reactions. Hence, the restlessness of the EBC itself.

The euro continues going up after Draghi's statements, the markets know that the ECB has little room for maneuver and that the accommodative policy will go on for some time. But the rising consequences, also take their toll on. Inflation expectations remain very poor and goods and services outside the euro area are becoming more expensive. A pricey euro hurts non-EU exports, the profits of large companies that sell abroad, business competitiveness outside our borders and the indebted and rentier sectors.

The increase of prices by decree does not work and the currency devaluation is not expected to occur. Meanwhile, some sectors benefit from this temporary limbo. A strong euro is good for savers, consumers, citizens traveling outside of Europe and importing companies. In addition, it improves the purchasing power and the investment capacity of citizens. But the currency volatility also implies financial risks. The result always depends on how the final eurozone balance tilts.

The euro and its evolution are a total defiance for the ECB. All that goes up, goes down later. Deflation is a fear that flies over the euro area. Nobody wants to go back to economic recession times. What will be the action plan? This is the Draghi's dilemma. The whole board depends on how and where the new economic policies are going. Be careful when moving the token!