It is easy to forget, but, only 5 years ago people were talking about the Euro as if it was doomed to fail. 1 Euro got you 86 cents. 5 years later and 1 Euro is worth $1.48 and people are suggesting the Euro is set to be the next global reserve currency.
The Euro’s strength is mainly a reflection of the dollars weakness.
US interest rates have fallen due to the threat of a recession in the US. This fall in interest rates, relative to the EU means the Euro has become more attractive as a place to deposit ‘hot money flows’
Also, unlike the US, the Euroarea has broadly equilibrium on its current account. Quite an achievement given the strength of the Euro.
In 2008, US interest rates have continued to fall, to try and negate the effects of the housing crisis. This could maintain the weakness of the Euro. However, the EU economy is showing signs of strain under the decline in export competitiveness. If growth in the EU slows, the ECB may follow the example of US and cut Euro interest rates. This would change the market dynamics significantly. The short term strength of the Euro may decline (much to the delight of EU manufacturers)
Long Term Forecast for Euro
The EU economy has been doing better in the past couple of years. But, there are real problems lurking in the shadows.
The Alternative to the Dollar.
Some people, who would like to see America go down in the world, have been taking great delight in the free falling currency. If the dollar continues to slide investors and holders of foreign currency may feel inclined to switch out of investing in dollars, but prefer the more stable Euro. This may also encourage people to hold reserves in Euros rather than dollars. If the Dollar does lose its position as most trusted currency, it will be harder for America to borrow at cheap interest rates.
Europe has an ageing population and inverted population pyramid. Furthermore European governments are tied to generous welfare benefits for the retired. European governments face a real crunch – How to finance its growing pension bill from a diminishing workforce. The problem is more acute in Europe than America. It could cause slower long term growth in Europe.