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What's behind the euro's comeback against the US dollar

February 9, 2023

The common currency took a battering in 2022, falling below parity with the US dollar as an energy crisis gripped Europe. The euro has now bounced back, offering big relief in the region's fight against inflation.

A generic image of a one-dollar note and a one-euro coin
The euro has regained much of the ground it lost against the dollar in 2022Image: Carol Smiljan/picture alliance

The euro has recouped much of the losses it suffered against the US dollar in the aftermath of Russia's invasion of Ukraine and the energy crisis that it unleashed.

One euro is now worth $1.07, up about 13% from September last year when it sank to around $0.95, a 20-year-low.

The resurgence of the common currency used by 20 countries in Europe has been spurred by a drop in energy prices, easing recession fears in the eurozone and the European Central Bank (ECB), which continues to aggressively hike interest rates.

The euro's rebound has also been aided by a weakening dollar as the US Federal Reserve slows its pace of monetary tightening in response to cooling inflation.

"Market expectations around the severity of the crisis in Europe just three months ago were just too extreme…too many speculators were betting on a real bad crisis in Europe stemming from the Ukraine energy war," Viraj Patel, a foreign exchange analyst at Vanda Research, told DW. "That just has not materialized in that way."

How did the euro fall below parity in the first place?

The euro endured a tumultuous 2022 as the war in Ukraine and Western sanctions against Russia pushed Europe into an unprecedented energy crisis.

Natural gas prices soared to record levels, derailing the region's fragile post-pandemic economic recovery. The worsening economic prospects, including soaring inflation and rising borrowing costs, prompted economists to forecast a deep recession in the eurozone, dragging down the euro.

While close economic ties with Moscow left the eurozone bearing the brunt of the energy crisis, the economic uncertainty quickly spread around the global economy. That prompted investors to take refuge in the dollar, seeing it as a safe haven. The dollar rose further against the euro.

The euro also suffered because of the ECB's initial reluctance to raise interest rates. That meant key rates in the eurozone fell well below those in the US, where the Fed got off the blocks earlier with aggressive hikes. Higher yields in the US attracted foreign investors, boosting the dollar.

"There was a feeling in the market that 'there is no alternative' to the dollar and therefore the dollar was so strong," Andreas König, head of global currency management at Amundi Asset Management, told DW. 

 Customers shop at a supermarket in Rome, Italy, March 2, 2022
High consumer price growth in the eurozone hit confidence in the common currencyImage: Jin Mamengni/Xinhua/IMAGO

Why did the euro rise?

The euro's rise in recent months has a lot to do with a milder winter in Europe. Warmer than normal weather, aided by an impressive effort in cutting gas consumption, has not only eased concerns around blackouts and energy rationing but also reined in natural gas prices.

The better-than-expected energy situation has brightened the prospects for the region's industries, suggesting that the eurozone may avoid a recession. The eurozone posted a surprise growth in output in the fourth quarter of 2022.

The common currency is also being propped up by the ECB's hawkish stance. The central bank continues to aggressively hike rates to arrest inflation, which remains stubbornly high, even as its peers like the US Fed slow down a bit.

"As interest rates in Europe rise faster than in the US, it benefits the euro and attracts capital inflows from elsewhere into the eurozone," Carsten Brzeski, chief economist for Germany and Austria at ING, told DW.

The euro has also gained from a general weakness in the dollar. The greenback has fallen against a host of major currencies, including the British pound and the Japanese yen, in recent months as easing inflationary pressures in the US offers the Fed some more room to tone down its aggressive monetary stance.

European Central Bank (ECB) President Christine Lagarde speaks to reporters following the Governing Council's monetary policy meeting, in Frankfurt, Germany February 2, 2023.
The European Central Bank plans to continue raising interest rates to fight eurozone inflationImage: KAI PFAFFENBACH/REUTERS

How does a stronger euro impact the economy?

A stronger euro will help bring down inflation by making imports cheaper, much to the relief of the ECB. Imports like oil and gas and other commodities are mostly denominated in dollars, so, when the dollar weakens, they become less expensive in euro terms.  

On the other hand, it would also make exports more expensive, hurting growth in export-reliant countries like Germany. However, Brzeski says the euro still hasn't reached levels where it could pose a risk to European exports.

"The negative impact [of the euro's rise] should be very limited," he said. "It could also be outweighed, for example, by the reopening of China as there would be more demand for European goods from China now, no matter what the currency is doing."

For European travelers heading to the US, a stronger euro means their currency would be worth a lot more there than it was in September.   

Where does the euro go from here?

The outlook for the euro remains uncertain given that the European economy is still not out of the woods. The threat of higher energy prices continues to linger, the war in Ukraine is still raging and a recession still hasn't been completely ruled out.

Most analysts agree that the euro wouldn't go much higher from its current levels this year. König and Brzeski see the euro fluctuating between $1.05 and $1.10 in 2023.

"The euro has done the easy part of the rally," Patel said. "This is a very tricky environment right now, in the next 6 to 12 months, especially in a recession."

Edited by: Kristie Pladson

Ashutosh Pandey
Ashutosh Pandey Business editor with a focus on international trade, financial markets and the energy sector.@ashutoshpande85