Can Europe Save Itself by Weakening the Euro?By
The euro celebrates its 16th birthday this month, and like a lot of teenagers, it’s hitting some rough patches. The currency has fallen 14 percent against the dollar over the past year, to $1.17 on Jan. 14, its weakest level in almost a decade. While he’s keen to avoid sparking an international currency war by actively encouraging its slide, European Central Bank President Mario Draghi is doing almost nothing to prop up the euro. That’s because a weak currency could be the region’s best shot at reviving its stagnant economy.
Exports account for almost half of Europe’s gross domestic product, compared with less than a fifth of U.S. and Japanese GDP. By making European goods more competitive, both at home and abroad, a cheaper euro could help boost growth and inflation. The ECB’s economic models suggest that a 5 percent decline in the euro’s trade-weighted exchange rate might lift GDP by 0.3 percent and inflation by as much as 0.5 percent. That may not sound like much, but it would be welcome news: The ECB expects the euro area to grow by just 1 percent this year, with an inflation rate of only 0.7 percent.
The benefits have been scant thus far. Europe flirted with recession in 2014. Consumer prices fell across the region in December for the first time in more than five years. Inflation remains below the ECB’s target of about 2 percent, and economists predict prices will keep declining this year. “We badly need more inflation,” Italian Finance Minister Pier Carlo Padoan told a European Parliament committee on Jan. 12. “We also could be helped by a weaker euro exchange rate vis-à-vis the dollar.”
Strategists surveyed by Bloomberg News predict the euro will continue to lose ground against the dollar through 2015. This month, Goldman Sachs became the latest bank to join the growing minority that expect the euro to fall to parity with the greenback by the end of 2016. Investors are betting that the risk of deflation will force Draghi to deploy even more monetary stimulus by buying up government bonds, which would further weaken the euro by increasing its supply. By contrast, the U.S. Federal Reserve is adding to the dollar’s appeal by considering raising interest rates for the first time since 2006. “The ECB has come round to the idea that the currency matters and getting it down is crucial for generating growth and inflation in a very export-driven economy,” says Nick Kounis, head of macro research at ABN Amro Bank in Amsterdam.
A cheaper euro could be a boon for some of Europe’s largest companies, which depend on exports for much of their sales. Sanofi, France’s biggest drugmaker, gets almost a third of its revenue from the U.S. Carlos Ghosn, chief executive officer of French carmaker Renault, told reporters on Jan. 7 that the euro’s drop “is good news, because it helps exports from Europe to other markets, or at least prevents imports to Europe.”
A weaker euro may still not be enough to accelerate growth in the region. Some of the benefits of a cheaper currency will be lost because European countries conduct so much trade with one another: About 45 percent of euro-area exports never leave the currency union. Whatever benefits producers gain in lower costs get canceled out by consumers’ lower purchasing power. A slowdown in China and Japan will also limit foreign demand for European goods, as will those countries’ efforts to weaken their own currencies. That’s a problem for the euro zone, which is desperately trying to improve competitiveness, says Janet Henry, chief European economist for HSBC.
As flawed a strategy as it is, lowering the value of the euro may be the best tool Draghi has at his disposal. The benefits of more monetary stimulus may not easily filter down to the broader economy, says Alberto Gallo, head of European credit research at Royal Bank of Scotland. Banks remain weak and may not pass the ECB’s stimulus on to consumers through lower interest rates. Companies will be reluctant to invest and hire until they see demand improve. Given those troubles, Gallo says, of the strategies available, a cheaper euro “is the only one which will obviously work in the euro zone.”
The bottom line: The euro has lost 14 percent against the dollar in the past year, and the ECB is choosing not to intervene.