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Euro-Dollar parity

  • Published
    19th Jul, 2022
Context

The euro and the U.S. dollar reached parity recently, meaning one dollar could buy one euro in the foreign exchange market.

  • For over two decades, it took more than one U.S. dollar to purchase one euro.
About

What is exchange rate?

  • An exchange rate is the value of one nation's currency versus the currency of another nation or economic zone.
  • Typically, exchange rates can be free-floating or fixed.
  • A free-floating exchange rate rises and falls due to changes in the foreign exchange market.
  • A fixed exchange rate is pegged to the value of another currency.
  • The rupee’s exchange rate vis-a-vis a particular currency, say the US dollar, tells us how many rupees are required to buy a US dollar.

How is the exchange rate determined?

  • The price of any currency in a market economy is determined by supply and demand.
  • The supply of a country’s currency in the foreign exchange market is determined by various factors such as central bank policy and the local demand for imports and foreign assets.
  • The demand for a country’s currency, on the other hand, is determined by factors such as central bank policy and the foreign demand for exports and domestic assets.

Why has the euro fallen against the U.S. dollar? 

  • The divergence in the monetary policies of the U.S. Federal Reserve and the European Central Bank is the primary reason behind the euro’s significant depreciation against the U.S. dollar.
    • The U.S. Federal Reserve responded to the rising prices by raising the interest rates this year in order to slow down U.S. money supply growth. 
    • The ECB has been far less aggressive in tightening policy even though the inflation rate is as high as 22% in some European countries.
      • This has caused the value of the euro to slide against the dollar as currency traders witness, or at least expect, the supply of euros in the market rising relative to the supply of dollars.
  • Another chief concern in Europe is energy prices.
    • After Russia invaded Ukraine, the U.S. and its allies imposed a broad array of sanctions and restrictions on Russian oil and natural gas.
    • That's driven up prices, and Europeans have been hit especially hard.
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