Rising oil prices and economic woes in Italy are adding to the mounting challenges faced by the euro, increasing the likelihood of it sliding back towards the crucial $1 threshold.
The euro, currently trading near its lowest point of the year at $1.05, has seen a 3% drop against the dollar in the third quarter, putting it on track for its third consecutive year of losses.
This decline can partially be attributed to the resilient U.S. economy and the influx of foreign capital as 10-year Treasury yields approach 5%.
However, euro-specific factors, such as exposure to soaring oil prices and a sluggish economy, pose further risks to the currency’s stability.
The euro is especially vulnerable to oil price fluctuations, as over 90% of oil products available in the European Union are imported.
Nomura’s G10 FX strategist, Jordan Rochester, warns that if oil prices continue to rise, reaching $100 to $110 per barrel, it may become challenging for the euro to avoid parity with the dollar.
Oil prices have surged nearly 30% in the last quarter, inching close to $98 per barrel, primarily due to supply constraints imposed by OPEC and its allies.
Barclays and other financial institutions anticipate oil prices reaching $100 in the near future.
Nomura forecasts that the euro will weaken to $1.02 by year-end, indicating a further 3% decline from its current levels.
Morgan Stanley’s chief Europe economist, Jens Eisenschmidt, highlights that the euro area is not only more susceptible to energy shocks but also more exposed to geopolitical risks compared to the United States.
These factors weaken the euro’s long-term prospects.
While a weaker euro can enhance export competitiveness, it also elevates price pressures due to increased import costs, exacerbating the impact of rising oil prices.
This may necessitate closer attention from the European Central Bank (ECB), though it appears unconcerned at the moment.
Although the euro only fell 0.9% on the trade-weighted index monitored by the ECB in the last quarter, it is still approximately 2% higher compared to the end of 2022.
The ECB had previously expressed concerns about the euro’s impact on inflation but did not specify a target level when it hit parity with the dollar last year for the first time in two decades.
Francesco Pesole, a currency strategist at ING, points to Italy as another cause for concern.
The yield premium on Italian debt compared to German debt recently reached 200 basis points, a level associated with a correlation between that premium and the euro.
Pesole suggests that if Italy’s bond market deteriorates significantly, the euro-dollar exchange rate could drop to the $1.00/$1.02 range.
In the near term, the euro faces additional challenges as investors, who have been betting on euro strength, may unwind their positions, exacerbating downward pressure.
Furthermore, with the ECB signaling the conclusion of its aggressive tightening cycle, the boost from higher interest rates has diminished.
In summary, a combination of rising oil prices, Italy’s fiscal struggles, and global economic dynamics is increasingly weighing on the euro’s prospects, potentially pushing it closer to parity with the U.S. dollar.