Does cheap euro further erode our purchasing power?

The declining purchasing power is currently dominating the economic news flow. However, relatively little attention is paid to an important cause of the decline in purchasing power: a weak euro. This is not likely to change with the current ECB policy.

The oil price is relatively much lower than the high petrol prices in the Netherlands would suggest. While the price at the pump has reached a record level, the price of a barrel of Brent oil is still well below that. In 2008, a barrel cost more than $140, while it is now just over $110. It is tempting to attribute the large increase in the price of petrol and diesel to high excise duties or the pursuit of profit by oil companies. But purchasing power is being eroded mainly by the cheap euro. In 2008 you got more than $1,50 for the coin. Today it is only $1,10. That difference may become even smaller in the near future. That's because the central banks on both sides of the Atlantic are charting a very different course.

Take care
The European Central Bank (ECB) made an advance on an interest rate hike towards the end of 2022 at the end of last year. The economic uncertainty and the enormous rise in energy prices threaten to put a significant brake on economic growth. As a result, ECB President Christine Lagarde and her fellow board members are faced with a difficult choice. Will they choose to go ahead with the plans and risk cutting economic growth in the bud? Or do they give the economy some relief, with the downside that inflation will remain quite high for the time being? On Thursday afternoon, the ECB showed itself in the cards: interest rates remain at the zero line. The only adjustment is that the stimulative buying policy of bonds and other assets is being scaled back a bit earlier than what the bank originally expected.

War or not: interest rates will rise
The US central bank has recently hinted that the interest rate hikes, which have been advanced in recent months, will simply come. The first move is likely to come at the Federal Reserve meeting next Wednesday. The CME futures market shows that interest rates in the United States will rise to 1,5% to 2% this year. Currently, the official interest rate is 0,25%. The prospect of a significant rise in interest rates is an important reason why the dollar has appreciated by more than 7% against the euro in the past six months. It should also be noted that the dollar is popular as a safe currency in uncertain times.

Dark side of a weak euro
This does not apply to the British pound, but this currency is also gaining ground on the euro due to a deviating interest rate policy. The Bank of England seems determined to raise interest rates for a third time in a few months next Thursday. In the past, attention has often been focused on the benefits of a weak euro for the European export sector. Due to the rising inflation and the CPB's calculation that purchasing power will fall by an average of 2,5% this year, the focus is increasingly shifting to the disadvantages of a weak euro. The large differences in international interest rate policy indicate that this is unlikely to change anytime soon.

Joost Derks

Joost Derks is a currency specialist at iBanFirst. He has over twenty years of experience in the currency world. This column reflects his personal opinion and is not intended as professional (investment) advice.

© DCA Market Intelligence. This market information is subject to copyright. It is not permitted to reproduce, distribute, disseminate or make the content available to third parties for compensation, in any form, without the express written permission of DCA Market Intelligence.