Parity between the euro and the dollar is undoubtedly a significant event in the world foreign exchange markets, which has not been here for 20 years. The single European currency has been falling against the dollar for almost a year and a half, with differing central bank policies playing a big part in the story. While the American Central Bank (Fed) gradually normalized its monetary policy, the European Central Bank (ECB) did not react to almost anything.
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The US dollar is currently supported by the US Fed, which fights inflation by raising rates, simultaneously widening the interest rate differential with most developed countries. The risk of a looming recession also favors the dollar given its reputation as a safe haven among investors. Meanwhile, the euro is under pressure from the ECB’s uncertain approach to interest rates and the higher risk of a recession on the continent, exacerbated by the doubling of local gas prices in the past month.
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In addition to the different monetary policies of the two central banks, there are other factors that lead to the weakening of the euro. One of them is definitely the war in Ukraine, which has a negative impact on the exchange rate of the single European currency. Russia has limited gas exports to Europe and there is a risk that it will completely cut off supplies of this key raw material. States that depend on Russian gas, especially Germany, could easily fall into recession.
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It’s a dollar
The achievement of parity between the two world currencies is a widely perceived milestone in the foreign exchange markets. But what does this mean for the domestic currency or local companies? For Czech companies, the reference currency is typically the euro, i.e. the key and monitored currency pair is the exchange rate of the koruna against the euro. It has been more or less stable in recent months, the Czech National Bank (ČNB) is preventing its possible significant weakening.
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In general, a strengthening dollar against the euro is negative news for Central European currencies against the single European currency, which are therefore coming under selling pressure.
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“We see it on the Polish zloty and the Hungarian forint. In the case of the Czech koruna, however, the situation is different due to the fact that the CNB actively prevents the weakening of the koruna against the euro with its interventions. However, it has no chance to fight against the trend of a strengthening dollar. This makes the dollar more expensive for Czech citizens and companies,” Jan Vejmělek, Chief Economist of Komerční banka, tells SZ Byznys.
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Since the beginning of this year alone, the koruna has weakened against the dollar by approximately 11 percent. Around 14:00 our time, one dollar was sold for 24.24 crowns on the foreign exchange market.
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“On a general scale, the weakening of the exchange rate helps exporters, however, the vast majority of Czech exports go to EU countries and payments are in euros. Therefore, this channel will not be as strong. On the other hand, a weak exchange rate makes imports more expensive, and a large part of the world’s commodity trade takes place in dollars,” adds Jiří Polanský, macroeconomic analyst at Česká spořitelna.
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The weakening of the koruna against the dollar has a negative impact on the Czech economy from a macro perspective.
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“There are significantly fewer exporters exporting for dollars, and therefore profiting from its appreciation, than there are importers for dollars. Key commodities and production inputs are traded in US currency. Even from our point of view, a stronger dollar means further increases in the price of inputs, and thus another pro-inflationary factor in an already turbulent inflationary environment,” says Vejmělek.
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“In these weeks, concerns about the development of the global economy are gradually reflected in the decline in the prices of oil, various metals, but also, for example, container transport, which subsequently means a decrease in some costs of Czech companies. However, a large part of the payments is in dollars, so in koruna terms, due to the weaker koruna against the dollar, this decrease in costs will not be as significant as it would be with a stable exchange rate,” adds analyst Polanský.
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Robbery for euros? Probably not
According to economists, is it theoretically possible that the state would now buy, for example, oil in euros instead of dollars? According to Jan Vejmělek from Komerční banka, everything is theoretically possible, but in practice the chances are minimal in this case.
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“Already in the past, we had similar thoughts here from time to time, without success. This would of course require the seller to be willing to sell for euros. But why would he access a less valuable currency? In addition, exchange rates change over time. When the dollar begins to weaken sometime in the future, will governments want to buy with dollars again? It is hard to expect that the reference currency would change according to the current exchange rate,” doubts the economist.
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“Oil is traded in dollars. States and companies can theoretically pay for it in euros, however, the development of the EUR/USD will already be reflected in such a price, which is why it would most likely not be profitable. In addition, the euro price could also include the cost of securing the exchange rate. In this regard, it is important that the vast majority of oil comes from countries outside the Eurozone. In addition, the dollar is still considered a safer currency than the euro,” adds analyst Jiří Polanský.
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Let’s not expect intervention from the ECB
Should the European Central Bank now behave similarly to the CNB, i.e. support the exchange rate with interventions? According to economist Vejmělek, the ECB should primarily use standard instruments such as interest rates.
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“Foreign exchange interventions are rather non-standard. Moreover, the weak euro is probably not the biggest problem facing the monetary policy of the eurozone at the moment. The Eurozone is a large closed economy where the exchange rate plays a smaller role than it does in the case of the Czech economy,” says Vejmělek.
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According to him, rather than a weak exchange rate, the problem of the eurozone and thus the ECB is high inflation and rising inflation expectations. “At the same time, the ECB monitors the issue of financial stability, primarily by looking at the development of government bond yields. And today, the problem of a significant increase in the cost of servicing the debt of highly indebted countries, especially from the south of the continent, threatens again.”
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“On the one hand, the weak euro helps exporters in, for example, Germany or France, but on the other hand it increases inflation, or will hinder its future slowdown. The ECB will most likely not use interventions. The first reason will be the effort to help exporters keep the currency, the second and more important reason will be not to start currency wars with the American Fed,” adds Polanský from Česká spořitelna.
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The crown is strengthening today
Even in times of the highest inflation since 1993, the Czech koruna has been strengthening, and on Wednesday it even reached its strongest position against the euro since February this year. Around 14:00 our time, the exchange rate was around the level of 24.39 CZK/EUR.
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“In recent weeks, we have seen interesting behavior in key Central and Eastern European currencies. While the Polish zloty and the Hungarian forint are weakening under the pressure of concerns about the sustainability of Russian gas supplies to Europe, the Czech crown is strengthening against the euro,” said Roman Ziruk, an analyst at Ebury.
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According to him, the Czechia generally has stronger macroeconomic fundamentals than Poland or Hungary and tends to be more resistant to shocks that can affect the exchange rate of the koruna.
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“It is unlikely that the movements we have seen in recent days reflect the actual market situation. It is more likely that the new banking board of the CNB has decided to proceed with drastic interventions to help moderate inflation,” he adds in conclusion.
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