European Economy: A weaker Euro won't solve the EU's problems this time

A weaker currency just reflects more accurately the EU's fragility. (Source: Bloomberg)

Parity between the euro and the dollar is starting to look inevitable, and that would normally be a competitive boon for a manufacturing export-led economy, such as the euro area. This time is different. Demand from two of the European Union’s main trade partners, China and Russia, is hamstrung by major domestic weaknesses and sanctions.

What’s worse, the weaker euro will stress the other side of the trade equation. With natural gas rising to the highest for two years, the energy import bill will likely head northward.

Plus, euro weakness will act as a brake on how quickly the European Central Bank can breathe in much-needed relaxation of monetary conditions. The ECB knows it needs to lower its key deposit rate further — having already cut four times since June. But cut too fast, and it will only accelerate the euro's descent. That could easily trip into existential worries about the whole common currency's viability. It doesn’t help the political environment is febrile in the largest European states.

While euro-area bank lending has seen two consecutive years of tightening conditions, even more worrying is the paucity of corporate demand for credit. Growth is increasingly scarce, and parts of the euro area are already in recession, particularly in the manufacturing sectors of Germany and France. Something fairly punchy must be done in order to keep the whole euro project on the rails. But whichever way the EU turns it comes up against restraints — mostly of its own making.

This loss of control over the EU's destiny — as it's smothered by a robust US economy fired by fiscal stimulus, AI fervour and an unusual combination of both being the only game in town and something of a haven — has tilted the playing field ever more acutely as tariffs and trade wars beckon. A reversal of many decades of increasing globalisation doesn’t benefit the euro area’s economic model at all.

Nonetheless, it's easy to become too doom-laden. Bank of America Corp's behavioural exchange-rate model assesses the dollar at a record overvaluation. But strong trends need a catalyst to change direction — it's anyone's guess what confluence of factors might cause King Dollar to stumble let alone when.

A swift resolution to the Ukraine war could deliver a positive surprise, not only taking the sting out of energy prices but also a potentially huge
defense rearming bill. A conclusive German general election in February might deliver a firmer mandate to boost fiscal spending. Sadly, hope is rarely a successful strategy. Without an EU-wide definitive growth plan combined with easier monetary conditions it's hard to mount a standalone case for the euro to appreciate.

Europe's exorbitant privilege - a relatively cheap common currency for the mighty German export machine to exploit in fertile Asian markets - is no longer in its quiver. Now, a weaker currency just reflects more accurately the EU's fragility. It's still the largest trading bloc in the world with 450 million consumers in 27 countries — there's strength in numbers — but only if everyone pulls together.

Credit: Bloomberg