A strong currency reduces the competitiveness of the economy but improves purchasing power.

 CURRENCIES Just six months ago, on March 20 , the euro hit a three-year low of $1.0657. Much of Europe was locked in a lockdown of uncertain duration. Masks were missing. Europeans closed their borders in cacophony, giving the impression of an " every man for himself ". The gap between sovereign interest rates (" spreads ") was widening, with the spectre of a new debt crisis. A wind of panic was sweeping through the financial markets, pushing central banks to heat up their printing presses like never before.

Six months later, the euro gained more than 10 % to flirt at the end of August with the $1.20 mark, its highest level in two years, before weakening slightly since above 1.18. To the point that the rise is beginning to cast a shadow over the recovery. The president of the European Central Bank (ECB), Christine Lagarde, normally not supposed to comment on foreign exchange, assured to " carefully monitor" the evolution. A strong euro is both a loss of competitiveness for Europe and another deflationary factor in a febrile economic climate. Inflation entered negative territory (- 0.2 %) in August in the euro area. But the movement may be in its infancy.

This surge in the European currency primarily reflects the weakening of the dollar. A safe haven in troubled times, the US currency had been boosted by the trade wars agitated by Donald Trump. But the sudden reversal of the US Federal Reserve that abruptly lowered rates to zero in the spring and injected billions into the economy, the surge in Treasury debt and the feeling of an uncontrolled progression of the pandemic have led to a investor mistrust of the greenback.

At the same time, the Europeans have pulled themselves together. The ECB's aggressive action has reduced the risk of fragmentation within the euro area. The announcement of a joint recovery plan by Emmanuel Macron and Angela Merkel on 18th May acted as a detonator to make the euro jump, stimulated again after the historic agreement 27 in Brussels on 21st July.

" Solid euro area "

" It's far from anecdotal," comments Louis Boisset, an economist at BNP Paribas. For years, the architecture of the euro area has been criticised for missing the budgetary arm. The recovery plan with a mutualized debt has given a strong signal on the solidity of the euro zone." "  There is a real change of perception on the European Union among Asian investors," confirms Patrick Artus, Chief Economist of Natixis. We are at the beginning of a period when the weight of the euro in international reserves will increase against the dollar. The traditional financiers of the United States, China, Japan or Russia, have become sellers of dollar debt." 

" There is still potential for appreciation for the euro, but probably at a slower pace," said Vasileios Gkionakis, head of fx strategy at Lombard Odier. Like most of his colleagues, he sees the euro appreciating between $1.20 and $1.25 in 2021, $1.27 at the end of 2021 for BNP Paribas. The " equilibrium " value reflecting a parity of the respective purchasing powers would be around 1.30. Provided that the recovery continues and that a new wave of the pandemic does not overwhelm Europe. Moreover, the outlook for the US elections, and in particular a victory for Joe Biden, does not appear to be favourable to a revival of the dollar.

The European Central Bank is watching over the grain, anxious to stop a deflationary spiral, without having much room for manoeuvre to influence the exchange rate. " We have been in an environment of exchange rate war since 2016. The U.S. Treasury and the Fed are best equipped to bring down the dollar. The ECB can retaliate but does not have enough weight to reverse the trend ," said Jonathan Baltora of Axa IM.

Import premium

This is the paradox of the economic weakening linked to a strong currency. Mechanically, a 10 % rise in the euro causes European exports to fall by 6 %. This is a bad omen at a time when industry relocations are being invoked. The most industrial countries, such as Germany or Italy, are affected in the first place. In France, sectors such as luxury, spirits or aeronautics are traditionally the most concerned (read below). But this effect is reduced by the current slump facing aeronautics or auto-mobile.

Conversely, the rise of the euro reduces the price of some 30 % of French GDP imported. For Patrick Artus, this ultimately amounts to " a tax on industry paid in purchasing power to consumers ". So it's " good for the economy ." " In the recovery scenario, the performance of domestic demand is more important than the effect of the exchange rate on imports, which is minimal on industrial attractiveness," said Bruno Cavalier, an economist at Oddo.