Euro Slips Toward Multi-Year Lows Amid European Political Instability and Debt Fears
The euro has dropped to a multi-month low against the dollar amid persistent economic weakness and escalating political risks in France and Germany, raising concerns about a potential sovereign debt crisis.
In the spring of last year, European Central Bank President Christine Lagarde stepped before the cameras to declare that the time had come for the euro to shine on the international stage. The U.S. president was then imposing tariffs on foreign trade on a daily basis and was locked in a fierce battle with the Federal Reserve. The dollar's status as a reserve currency was shaken, its exchange rate against the shared European currency plunged to a four-year low, and Lagarde predicted that the euro's "global moment" was now beginning.
As of the past week, that moment has not materialized. In recent weeks, the euro has fallen to a low of nearly a year and a half against the American currency. In early-week trading, the euro dropped to a level of $1.11, whereas when Lagarde delivered her remarks and estimated that demand for the euro would rise, it stood at 1.18. Since the beginning of the year, the value of the shared currency for 20 economies in the European Union has declined by about 4% against the dollar.
Economic and Monetary Weakness in Europe
In Europe, efforts have been underway in recent days to understand the dynamics explaining this trend. On one hand, a significant factor strengthening the dollar globally may be the policy of the U.S. Federal Reserve. According to this explanation, facing an inflationary threat that also impacts government bond yields, the Fed will continue to raise interest rates in the economy—a move supposed to strengthen the dollar in international comparison.
However, most explanations at present are intra-European, concerning economic and monetary weakness on the continent rather than the strengthening of competing currencies. The danger of a debt crisis in the European Union is significantly greater than in other regions, partly due to its unique structure as a monetary union rather than a fiscal one.
France, the EU's second-largest economy, is teetering on the verge of a debt crisis, with its national debt expected to cross the 120% of GDP threshold this year, while the political situation shows no sign of a near-term resolution. On Monday, the governor of the Bank of France issued an extraordinary warning in an interview with the Financial Times. He stated that if the French government fails to pass a budget with a minimal deficit in the coming months, demonstrating that the country takes its debt problem seriously, "there is indeed a risk that we will become gradually choked by rising interest rates."
Escalating Debt and Political Instability
Last year, France paid no less than 70 billion euros in debt interest, and this rate is only expected to rise now as French government bond yields sit at a two-decade high. Against the backdrop of burning schools and populist promises by leading political camps ahead of the upcoming presidential elections in April-May, it is difficult to see how the government will meet this burden.
The recent sell-off, according to an analyst at the consulting firm Oxford Economics, "stems in particular from concerns regarding France, where investors are bracing for higher fiscal risk."
Adding to the political instability affecting the currency was the announcement by Spanish Prime Minister Pedro Sanchez earlier this week regarding snap elections to be held on November 29. Furthermore, the shaky state of the German coalition, which suffered an unprecedented defeat in a series of state elections, does not help instill confidence in the future.
The Impact on the Eurozone and Markets
The impact of these developments goes beyond the domestic level, as seen in France, by undermining the standing of the European Union—and consequently the euro. Faced with surging yields on Italian and Greek bonds, for instance, the European Central Bank previously executed a massive purchasing program that artificially lowered them. Should France require this mechanism, it is supposed to be at its disposal, particularly under Lagarde's tenure.
"In the next six months, anyone investing in Europe will not be able to ignore political issues," wrote a German analyst in the Frankfurter Allgemeine Zeitung.
Yet how would Germans, pressured by populist parties, react to such support for France? Already, the debate in Germany leans more toward Euroscepticism than ever before. Up to now, European nations have managed to pad their path to political stability by dispersing government funds and deepening debt. If this era is drawing to a close, the implications for the euro—and beyond it—could be profound.
Currency Depreciation: Blessing or Curse?
In the short term, ING Bank, among others, estimates that the euro will continue to slide toward the $1.1 mark. Meanwhile, some are satisfied with the course of events. Generally speaking, a lower value assists European exports. The euro has weakened not only against the dollar but also against the Swiss franc and the British pound.
"This is both a blessing and a curse," wrote analyst Jochen Stenzel, pointing to recent gains in Germany's DAX index and noting that "most companies included in the index benefit from the depreciation in currency value through a more successful export outlook."
In France, the economic newspaper Les Echos pointed out that "the euro's plunge against the dollar, largely driven by political risk in France, could prove very profitable for the country's companies."
According to calculations published by Goldman Sachs, every 10% drop in the value of the euro against the dollar translates into a 2% to 4% increase in earnings per share for the 600 companies included in the pan-European Stoxx 600 index.
In the long term, investors and analysts are searching for alarming signs that the eurozone may be facing a new sovereign debt crisis. "The big question is whether this is the beginning of a new sovereign debt crisis in the eurozone, or whether the markets have already gone too far beyond reasonable measure," wrote a Deutsche Bank analyst. During the previous crisis, the euro was rescued by statements from then-ECB President Mario Draghi that the bank would do "whatever it takes" to support it. Today, Europe is an entirely different continent.
