Will the Euro Do a Dollar in 2023?

For a long time, the dollar was untouchable in the currency world of 2022. However, the euro has been catching up in recent months. The European currency can make a good start in 2023. However, the prospects for later this year are less bright.

Tomorrow the provisional inflation figure in the eurozone for December will be released. It will be very exciting to see if this percentage is just at or below 10%. This does not make much difference to the policy of the European Central Bank (ECB). In the last months of the new year, chairwoman Christine Lagarde has not missed an opportunity to emphasize that she is doing everything she can to bring inflation back to a level of 2% in the medium term.

Mārtiņš Kazāks, the chairman of the Latvian central bank, added some extra fuel to the fire as a member of the ECB Governing Council just after the turn of the year. In an interview, he said that interest rates will be raised significantly in February and March. In the financial world, two interest rate increases of 0,5% in the first months of 2023 were already taken into account. The last doubts about this have now largely been dispelled.

Vigor
The decisiveness of the ECB is in stark contrast to the doubts expressed by the central bank twelve months ago. At the time, inflation was dismissed as a temporary effect in the aftermath of the pandemic. In the first half of the year, the bank did little more than reverse stimulus measures. In retrospect, it seems that this policy has stoked the fire under economic growth and especially inflation a little too hard.

There is a good chance that in twelve months it will become painfully clear that the ECB not only reacted too late to the flaring inflation, but also switched back too late when that inflation had passed its peak. For example, the oil price is lower than a year ago, while the major price increase was still to come. The way in which energy prices feed through to the costs of various products and services alone suggests that inflation could fall sharply in the coming months.

Turning point of the euro
On foreign exchange markets, the ECB's aggressive policy is providing a strong tailwind for the euro for the time being. The currency has appreciated 10% against the dollar since the last week of September. A year ago, the US currency actually benefited from the interest rate hikes implemented by the Federal Reserve.

After a strong start, the dollar has lost quite a bit of luster since the fall when it became clear that the Federal Reserve is cautiously taking its foot off the interest rate accelerator. If it becomes clear in a few months time that the ECB will do the same – or that the European economy will cool down faster than expected – the reverse picture of last year may emerge in the currency world.

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.

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