This week the euro soared to its highest exchange rate in history, sparking fears that the common currency's ascent could do more harm to Europe's national economies than good.
The strong euro is threatening to cause deflation.
European exporters are breathing a sigh of relief that the euro has dipped again against the dollar. The European single currency reached its highest trading level earlier this week.
The record high of $1.1933 on Tuesday topped the euro’s initial trading price of $1.1789 in January 1999. But the greenback gained ground against the euro on Thursday, trading at around $1.17.
The dollar’s recovery is being attributed to prospects of a cut in European interest rates. The chief economist for the European Central Bank (ECB), Otmar Issing, told a Finnish financial newspaper that a strong euro helped tame inflation and gave the ECB elbow room on rates.
"It goes without saying that the slowing of inflation is linked to the strengthening of the euro, and through this, the room for maneuvering in monetary politics has changed," Issing said in an interview with Kauppalehti.
The financial markets will keep their eyes on next Thursday's ECB meeting to see if the body will cut interest rates from the current 2.5 percent, possibly by as much as half a percentage point. A slash in interest rates would reduce the differences between the euro zone and the U.S. financial markets, consequently lowering the incentives for funneling capital to Europe.
With respect to Germany, Issing said the trend of prices could turn negative with a risk of deflation. "If we talk about specific countries, like Germany, no one can rule out the possibility that, at these low inflation levels, also the zero boundary will be broken," he said.
German economy not in danger
On Wednesday, German Economics Minister Wolfgang Clement said he saw "deflationary risks, but no concrete danger" for both Germany and the U.S. He dismissed fears by members of parliament in the ruling Social Democrat party that Germany faced a deflation with continuing declining prices and falling demand.
The minister (photo) said that companies in the eurozone's largest economy would have to come to terms with the current strength of the euro. He acknowledged, however, that it could pose some problems for exporters. "But the economy must and will live with this," Clement said.
Clement said it was "not a bad sign that the euro is now showing its strength" following the past debate about the weakness of the single currency. He estimated that the euro-dollar exchange rate would "work itself out".
Higher unemployment through weak exports
The strong euro is not beneficial for the euro zone economies because a high European currency rate puts pressure on the export sector. German products, for example, become more expensive for U.S. buyers due to the higher exchange rate.
Only some ten percent of German exports are produced for the U.S. market. But these are key industries, such as automobile manufacturing or engineering. These are sectors that require a lot of personnel. If these companies have difficulties selling their products in the U.S. because of the strong euro, this will eventually mean job cuts, and, in the long run, higher unemployment.
Economics Minister Clement, who visited the U.S. last week, said he had received assurances from leading officials that Washington was not adopting a soft-dollar policy. This was "absolutely not the case," he said.
Both the Chairman of the Federal Reserve Board, Alan Greenspan, and Treasury Secretary John Snow had assured him that the U.S. was in no way using the exchange rate to strengthen the weakened export economy in the U.S.