Threats Cloud Euro's Flight

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1). Currently, when the Euro is compared to dollar, it can be seen that 1 Euro is equal to 1.3662 US dollars. In order to find out the extent of how much Euro has appreciated over a year, it is important to first identify the value of Euro against US dollar one year ago. In February 2012, the maximum value of exchange rate between Euro and US dollar was 1.3056 whereas the minimum rate was 1.349 which gave an average of one Euro being equal to 1.3236 dollars. If the average value of Euro relative to US dollar is taken into account to calculate the rate of appreciation, it can be said that over the period of one year, Euro had appreciated by 3.22%. The explanation of this value is as following:
Appreciation of Euro over a year = 1.3663-1.3236/1.3236*100 = 3.2185% ~ 3.22%
The following table shows the trend of Euro and US dollar from 1999 to 2009
 

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2). When a currency appreciates over another currency, it means that its value increases relative to the other. This phenomenon can take place due to various reasons which can be both internal and external in nature. Same is the case with the appreciation of Euro which has been affected due to domestic and global factors over the past few years which has increased its value when compared to that of US dollar. When discussing the domestic issues which have led Euro’s appreciation, it is important to mention that the interest rates affect the tastes and preferences of people when it comes to investing in any currency.
If the interest rate of any country increases, it allows more people to get interested in saving their money because they would speculate getting additional amounts on the money that they would deposit in their banks. In the case of European nations, the interest rate had increased from 1.25% to 1.5% which is considered to be the second increase in the interest rates which have been conducted by the European Central Bank (Atkins, 2011). This is why even though the European nations are facing threats of debt crisis within the euro zone, they are still able to appreciate Euro as people are aiming to deposit their money in the domestic banks instead of spending it so that they can earn considerable amount of money as a result.
Another reason for the appreciation of interest rate is the expectation of people which leads to their change in tastes and preferences. This expectation of people may also change due to many reasons, such as the ability of government to pay back the loans that they currently have. Despite the pressure faced by European nations to pay back the loan and the risk that they faced when it came to their capacity to repay loan, the cheap loans were still expected to be repaid.
Also, whenever people expect their domestic currency to increase further as compared to other currency, or vice versa, it would mean that they would change their expectations accordingly. In the case of European nations, during the past year, the population of European nation expected their own currency to appreciate, which means that people preferred investing in Euro as they were more confident about this currency and thus this allowed Euro to further appreciate, resultantly (Economics help, 2012)
The global reason for appreciation of Euro can be associated with the rise in the imports within the European nation due to the increase in the value of currency. When the Euro currency appreciates, it becomes possible for the nations within the Euro-zone to import goods from abroad at cheaper rates. The expectation about foreign currencies thus plays an important role in appreciation or depreciation of domestic currency. In the case of Euro, people were expecting dollar to further depreciate when compared to Euro, thus this had a rebounding impact upon Euro currency which appreciated as a result.
3). When the Euro appreciates, there is a probability that this increase in the value of Euro can both improve the economy of European nations and also hurt the countries simultaneously. When the Euro appreciates, it would mean that the nations would be able to increase their volume of imports as the foreign goods would become more attractive to them. On one hand, this would benefit the population in the short run as they would be able to consume more goods at cheaper rates. On the other hand, when the imports would started to exceed the exports of European nation, it would gradually start to cause current account deficit to take place which, if not covered by the balance of payments, it may cause the economy to suffer in the long run and resultantly, the exchange rate would start to start to depreciate (Charilaou, 2012). Also, the attraction of foreign goods would cause the domestic firms to suffer as the demand for their products would decrease and thus they would not be able to generate sufficient profits for their smooth functioning.
4). The dollar had been affected by the Federal Reserve as it had eased up its quantity of money that it floated to the population. Also, the government is now taking measures to stimulate their monetary policy so that they could help decrease the interest rates however, this measure would still take time and necessary action by the government to maintain their efforts for this purpose. On the other hand, in recent past, the government has not been able to improve the interest rates because it has not been able to increase the confidence of people in terms of their credit policies and thus they are not able to increase the demand for credit (Elwell, 2012).
In the case of nations within Euro-zone, the monetary policy has been tightening. It has been the role of the monetary policy which has allowed the European nations to improve their situation and cause the currency to appreciate despite the fluctuating performance of these nations. Monetary policy has significant impact upon the interest rates, economic output, exchange rates and exports of the nation (Dehesa, 2011).
When the monetary policy is expanded, it causes the exchange rate to depreciate as a result. Similarly, when the amount of money is increase within the economy, the banks are more willing to offer loans to people at lower interest rates. On the other hand, the domestic current account would improve as the demand for exports would increase more than the imports and thus the total output may also increase as a result and thus may be beneficial for the economy if the country wants to improve their current account and decrease their exchange rate. The same is possible for a country if it wishes to improve their economic performance due to monetary policy contraction.
5). The European Central Bank should try to incorporate measures to expand its monetary policy so that it can facilitate the domestic firms which are suffering due to the continuous increase in the value of the Euro due to its appreciation. Even though Euro appreciation has been beneficial for the euro-zone nations due to their ability to refine the level of confidence on foreign investors however, if this continues in long run as well, it would cause the nations to suffer as a result. Thus, ECB should try to encourage monetary policy expansion which means that the volume of money which would floats in the economy would increase and would cause the value of the currency to fall. This would increase the inflow of foreign currency reserves and can be beneficial for the growth of the countries as a result.
Summary
There have been various reasons due to increase in the worth of dollar which has reached to its peak in November 2011 however, the investors predict that it may not be possible for the currency to appreciate in future after a certain limit. Also, ECB may try to decline their exchange rate as other central banks are also making efforts to decrease their own exchange rate. This can cause the Euro to reach towards it neutral position which is known to be most desirable for the country and other nations as well. The decision of keeping the euro-zone intact may be beneficial for the nations by facilitating the bonds market. Majority of the investors are now demanding to buy more euros as compared to dollars because they expect the dollar to further reduce in terms of its value in near future.
Because ECB previously provided people with inexpensive loans but by allowing repayment of loans, it further increases the pressure on euro.  Furthermore, if the currency appreciates, it becomes difficult to attract people to buy their goods as they become more expensive an as currently, ECB has not declared their currency to be overvalued, no significant efforts have been made to depreciate it which further increase pressure on ECB to expand their policy in future. Accordind to Phillipe Bonnefoy and Eleuthera Capital, there is a probability that the euro zone would soon provide negative data which can hinder their growth prospects and thus the currency can range between $1.35 and $1.37. Philippe Gougenheim expects the currency to appreciate and thinks that it may be $1.3 within six months.

 

References

Artus, P. (2009) When does the euro appreciate?, 1 September, [Online], Available: http://cib.natixis.com/flushdoc.aspx?id=48518 [3 February 2013].
Atkins, R. (2011) ECB raises interest rates to 1.5%, 7 July, [Online], Available: http://www.ft.com/cms/s/0/a4f92816-a87f-11e0-8a97-00144feabdc0.html [3 February 2013].
Charilaou, C. (2012) High-growth economies drive euro appreciation, [Online], Available: http://www.worldfinance.com/home/news/highgrowth-economies-drive-euro-appreciation [3 February 2013].
Dehesa, G.D.L. (2011) Fiscal and Monetary Tightening plus Euro Appreciation-A perfect recipe for lower growth in the Euro Area, February, [Online], Available: http://www.europarl.europa.eu/document/activities/cont/201106/20110615ATT21428/20110615ATT21428EN.pdf [3 February 2013].
Economics help (2012) Factors which influence the exchange rate , [Online], Available: http://www.economicshelp.org/macroeconomics/exchangerate/factors-influencing.html [3 February 2013].
Elwell, C.K. (2012) The Depreciating Dollar: Economic Effects and Policy Response, 23 February, [Online], Available: http://www.fas.org/sgp/crs/misc/RL34582.pdf [3 February 2013].

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