Eurozone: No Respite from ‘Weak’ Euro
Bottom line: Although the euro is now trading at a 20-year low of around parity against the dollar, this is more reflective of strength in the U.S. currency. Indeed, on a trade-weighted basis, the euro is hardly weak at all, especially on the broader measures (Figure 1). Regardless, what weakness does exist is hardly providing any support to EZ exporters and only partly as the euro is a dominant currency so that much EZ trade is invoiced in euros. Instead, soaring energy prices (accentuated somewhat by dollar strength) are undermining EZ competitiveness, all the more ironic as the recession risk such cost pressures are precipitating is seemingly the root cause of the euro's woes.
Figure 1: Different Perspectives on Euro 'Weakness'
Source: Continuum Economics, ECB
The Euro in Different Guises?
Much has been said about the recent return of the euro to parity with the dollar. Few, however, are suggesting that this is unambiguous euro weakness, as the strength of the dollar is evident against a wide range of currencies. Indeed, on a trade-weighted, or effective exchange rate, basis, the euro is still relatively strong on the broader measures that incorporate some 44 other currencies (Figure 1).
On a narrower trade-weighted basis, the euro has fallen, but this very much reflects the weighting of the dollar on an effective exchange rate involving just 12 currencies. Moreover, in real terms (where the nominal exchange rate is deflated by relative swings in producer prices), the euro has actually risen of late (Figure 2), diverging from the nominal path, although this is unlikely to persist as energy price strength leads to more sustained PPI increases.
Figure 2: The Euro in Real vs. Nominal Terms
Source: Continuum Economics, ECB
EZ Exporters More Concerned
It is unlikely that this rise in the real euro rate is responsible for the gloomier assessment of competitiveness evident in the European Commission's quarterly survey. As Figure 3 highlights, and very much in contrast to the pre-pandemic past, the fall in the euro has coincided with an increase in survey respondents suggesting greater pessimism about their competitive position with non-EZ countries. This occurred temporarily during the COVID crisis as companies faced unprecedented drops in demand and supply.
Figure 3: EZ Exporters More Concerned about Competitiveness
Source: Continuum Economics, ECB, European Commission
However, the most recent perceived deterioration in competitiveness surely is a result of the surge in costs companies are facing, predominantly in energy. Indeed the recent increases in energy, and especially gas, prices endanger not only exports but also an actual ability for EZ companies to produce goods at a profit, and therefore at all. This possibility is perhaps the reason why FX markets are focusing on the increased recession risk that the EZ is facing.