Question

explain the factors that determine the Euro/US exchange rate in the Foreign exchange market in recent years?

Answer 1

US dollar ($) and Euro (€) are the two most important reserve currencies in the world which are used for international trade. This is naturally due to the economic prosperity that both the US and Europe has achieved which in turn gives them credibility and trust in the international market.

These two currencies compete against each other for trust in international trade and hence, the movement in exchange rate between them is a crucial indicator of their relative strength in international trade circles.

US $ has gotten stronger against Euro consistently in recent years. This behaviour in US$/€ exchange rate has been driven by the following factors:-

1) GDP growths post 2008 recession: While the recession of 2008 hit the entire world, Europe has turned out to be more badly hit than the US. While US economy quickly got back on track in next few years of recession with respectable GDP growth rates, most European countries have struggled to get back the GDP growths resulting in weakening of Euro against dollar

2) Monetary policies: We live in an era of monetarism where in bad times, the governments rely on severly cutting interest rates to get the money flowing in the economy in pursuit of getting economic growth back on track. Post recession, both US and the Europe have resorted to very low interest rates to kick start the economy, but the inability of European countries to get growth back coupled with loose monetary policies (including negative interest rates) have impacted the value of Euro, resulting in dollar getting stronger against it.

3) Questions on European Union: The brexit issue and political instability in few European nations have raised doubts on the strength of European Union and hence the Euro. If the EU member countries show any signs of inability to stick together, it directly impacts the value of Euro in international market. The decision of Britain to leave European Union as well as political instability in countries like Greece, Italy, etc have helped USD gain strength against the Euro.

4) Europe's debt problem: Many European countries such as Greece, Italy, Spain, etc have had faced high levels of debt in recent years, which when coupled with extremely low economic growths, have dented the overall economic performance of the European Union and hence the value of the Euro against the dollar.