Since mid-July, the euro has depreciated by more than 5% against the dollar, reaching $1.04 at the start of the month. This decline is due to a combination of circumstances that have significantly impacted the currency in this second half of 2023 after a solid second quarter.
One of the main factors putting pressure on the euro is the economic slowdown in Europe, mainly due to weakness in the manufacturing sector, which continues to be affected by trade with Asia, and rising costs of intermediate goods. Although services, particularly those related to tourism, have held up better, they are also showing signs of slowing down. On the other hand, the US dollar has been supported by the strength of the US economic cycle, where consumption and employment appear to be more resilient than expected to restrictive monetary policy measures and a recession is likely to be avoided, which was previously forecast for early 2024. This has encouraged more aggressive monetary policy the Federal Reserve (Fed), which, although the cycle of interest rate hikes may be over, does not completely rule out the possibility of another increase or at least suggests that it will keep them high for longer.
In addition, another determining factor has come into play in recent weeks: the conflict in the Middle East. Even if the euro is not yet affected, this situation affects Europe primarily due to its energy dependence and is reflected in inflation and uncertainty about economic growth. Meanwhile, the United States is in a relatively better position due to its lower overall energy dependence. Furthermore, this environment of uncertainty and fear of escalating conflict would theoretically favor the dollar due to its safe-haven status.
What could trigger a change of course by 2024? The interest rate differential, which is currently putting pressure on the value of the euro, is likely to narrow in the coming months. The Fed is expected to begin its rate cutting cycle in the middle of next year, while the European Central Bank (ECB) is not expected to do so until late 2024. In addition, the markets are turning their attention beyond the doubts. If the growth of the European economy, the slowdown of the US economy next year are confirmed and the outlook on the main risks is clarified, this weakness of the euro would gradually reverse and become a very gradual rise of the currency against the dollar in 2024.
María Martinez, BBVA Research.
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