Will a stronger euro ruin Europe's rally?

International investors have been buying into European stocks, driving the euro higher. But that surge now risks dampening the recovery that started it.

The euro has gained 8% against the US dollar this year. In response, European Central Bank (ECB) president Christine Lagarde has promised to “monitor carefully” developments in the foreign exchange market. 

A rising euro creates two problems: firstly, it means lower import prices. Eurozone consumer price inflation turned negative in August, so more deflationary pressure is unwelcome. Secondly, it hits the earnings of exporters, especially significant in a bloc where exports make up about 45% of GDP and bourses are crammed full of multinationals. 

Confidence in Europe’s economic recovery has encouraged international investors to buy into local markets, juicing the euro’s rally, says Jack Ewing in The New York Times. Ironically, that surge now risks dampening the recovery that started it. The ECB would prefer a weaker currency, but there is a tacit “non-aggression pact” between big central banks when it comes to exchange rates: actively talking down the euro would risk retaliation from Washington, sparking a self-defeating “currency war”. 

In any case, as Andrew Kenningham of Capital Economics points out, the current valuation is hardly eye-watering: the euro last traded at around $1.18 in 2018 and was as high as $1.38 back in 2014. The stronger euro will thus be a headwind, but it looks unlikely to sink eurozone stocks.

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