Currency can be volatile, especially in the wake of recent global events that caused much of the world to go into complete shutdown. What we’ve seen happen recently is the Euro (EUR) decline in value to almost the same value as the US Dollar (USD).
In this article, we’ll be investigating why this happened and whether the Euro can recover. Whether you’re doing research so you can trade forex now or just so that you can have a better idea of the situation, this should help you understand.
Why do currencies lose value?
To start, we’ll look at why currencies lose value and how this can happen as there are often many reasons, and it has even more ramifications.
Inflation is one of the most common reasons why any currency may begin to lose value. Inflation is the rate at which products and services increase in cost over a set period of time. If the inflation rate in a country increases, money is often worth less, and it takes more money to buy a product.
This can have wide-reaching consequences and can cause issues in countries where the economy is already struggling. This loss in purchasing power can result in a domino effect, causing people to start hoarding cash because they believe that it will be worth more in the future; this causes even more inflation. It’s a vicious cycle.
Economic uncertainty can also play a key role when it comes to a currency losing value, as this can affect investor confidence. When there are times of uncertainty or instability, many investors will pull their money out of the market in an effort to protect their assets, in turn damaging the economy and contributing to the issue.
So, what's been hurting the Euro?
The Euro has been in sharp decline for some time, falling for months on end, and is now at the same level of value as the US Dollar. This time last year, one Euro was worth $1.20, and even just at the start of the year, the Euro was still worth $1.13. Fast forward eight months and the Euro has now dipped below $1.
There are a couple of key reasons as to why the Euro has seen such a sharp decline of late, though there are many smaller contributing factors to also factor in. One of the factors, according to Sushanta Mallick, an international finance professor at Queen Mary University of London, is rapidly rising inflation within the entire EU.
With an average inflation rate of around 9% across the EU, both people and economies are really struggling. While many countries, especially in the west of the EU, made a strong bounceback following the height of the pandemic, the Ukraine-Russia conflict has put much of this recovery on hold.
The other key factor, which may be much harder to solve, is that growth within the EU has ground to a halt, as we alluded to previously. While interest rates can be addressed by government-backed incentives, growth is an entirely different beast as it depends on many varied, often competing, variables.
One way a country may counteract this is to invest in itself and kickstart the economy. Essentially, this means betting on itself that this investment will be enough to get money into the pockets of people and get them spending. This can work, but with the EU being so large, it will require a consistent rollout to be effective.
How can a currency recover?
There’s no one answer that will work for every currency as the situation is different for each one. In the case of the Euro, it may be a good idea to focus on getting inflation under control and jumpstarting growth within the EU. This could take some time but, if successful, could result in a much higher value for the Euro down the line.
While the US economy is faulted and often highly volatile, the annual announcements regarding budgeting and economic growth go a long way in helping to ensure investors continue to bet on the economy staying strong, something which is much harder to do in the EU.
There are a variety of methods that a government may use to try and increase the value of its currency, but it’s often a complex and difficult task. Some common methods are raising interest rates, decreasing government spending, or increasing taxes.
Some of these actions will be hugely unpopular. Actions such as decreasing government spending are unlikely to be accepted by the general population as it will often mean cuts to essential services such as healthcare, education, and welfare. These are all non-negotiables in Europe.
With tax increases also completely out of the question when it comes to Europe, people are already struggling as it is; the only option is increase interest rates and hope that investors see this as a positive step, and this will help reduce inflation. It’s a real sticky situation.