The strong rise of the euro is no longer merely a supporting factor for the European currency; it has become an additional pressure on the Eurozone economy, especially amid the significant expansion of low cost Chinese exports. This interplay between the strength of the euro and Chinese export momentum creates a price contractionary environment, which may prompt the European Central Bank (ECB) to reconsider its current stance and potentially resume interest rate cuts at a later stage.
Currently, the euro is trading near $1.166, after reaching a peak of $1.1918 in September, and is on track to achieve annual gains of around 13%, its strongest performance since 2017. This surge reflects a significant improvement in the euro’s pricing against the dollar but simultaneously puts pressure on the competitiveness of European exports.
When measured by the inflation weighted real effective exchange rate, the euro’s strength is even greater than what is visible in direct dollar trades, reaching its highest level in over a decade. The trade weighted nominal exchange rate has also hit historic highs, confirming that Europe is facing a strong currency across most external trade fronts, not just against the US dollar.
One of the main drivers of the euro’s trade weighted strength is the sharp depreciation of the Chinese yuan by about 7% this year, while China remains Europe’s largest trading partner. Recent data show a widening European trade deficit with China compared to a surplus with the United States, indicating that Europe faces direct price competition from Chinese goods both domestically and abroad.
The ECB remains officially in a wait and see position, stating that the current euro levels have not yet reached a dangerous threshold. However, surpassing certain levels could turn the currency’s strength into a direct burden on growth and exports. At the same time, the impact of the euro’s rise on inflation remains limited so far, as companies continue to rebuild their profit margins.
The US dollar started the week with a modest decline, as markets focused on the Federal Reserve meeting amid almost certain expectations of an interest rate cut. The dollar index stabilized near its lowest level in five weeks, signaling that traders are betting on an actual policy shift during Wednesday’s meeting.
The dollar’s decline was supported by data showing slowing inflation and clear signs of weakening labor market momentum. Futures market pricing indicates an over 88% probability of a rate cut this week, while investors await US job openings data as the last test of labor market strength before the Fed’s decision.
Although the Fed’s decision may provide temporary support to the dollar, seasonal year end pressures, along with growing speculation about potential changes in the Fed’s leadership, place clear limits on any strong upward move for the US currency at this stage.
The British pound saw a limited decline after recently approaching a six week high, as traders repositioned ahead of the upcoming Bank of England meeting, anticipating potential changes in the tone of monetary policy.
In Asia, the dollar rose slightly against the yen following revised GDP data showing Japan’s economy contracted faster than preliminary estimates due to weak investment spending and declining exports. Nevertheless, markets still expect the Bank of Japan to consider a rate hike, with special attention on wage data and official statements.
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