The year 2022 witnessed extraordinary volatility in the euro’s value, leading analysts to label it the “worst year in the euro’s history“. Starting the year at an EUR/USD exchange rate of $1.137, the euro experienced a significant downturn, breaching parity with the US dollar in July for the first time in two decades, marking a 20-year low. The Euro To dollar exchange rate further plummeted to a year-to-date (YTD) nadir of $0.960 on September 27th, coinciding with the indefinite shutdown of the Nord Stream 1 pipeline. However, following the European Central Bank’s (ECB) decisive 75 basis-point policy rate hike on October 27th, the euro rebounded, closing the year above parity with the EUR/USD rate reaching $1.07.
Figure 1 US dollar to euro spot exchange rate
While the global economy grappled with the repercussions of the pandemic and the Ukraine crisis, Europe faced amplified challenges. Specifically, three primary factors contributed to the euro’s depreciation against the dollar in 2022:
- Europe’s Energy Dependence and the Ukraine Crisis: The significant reliance of European nations on Russian energy sources, coupled with the economic repercussions of the Ukraine invasion, heavily impacted the euro.
- Monetary Policy Divergence: The widening gap in monetary policy approaches between the US Federal Reserve (Fed) and the ECB further weakened the euro to USD exchange rate.
- The US Dollar as a Safe Haven: The traditional role of the US dollar as a ‘safe haven’ asset during periods of global financial and political instability drove investors towards the dollar, increasing its value against the euro.
The Impact of the Ukraine War and Energy Crisis on the Euro to Dollar Exchange Rate
Russia’s invasion of Ukraine severely destabilized the global economy, disrupting trade flows and triggering sharp increases in food and fuel prices. Europe, due to its geographical proximity and energy dependence, felt these effects more acutely than other regions. The European Commission’s Autumn 2022 Economic Forecast projected that most EU member states would enter a recession in the final quarter of the year, attributing this to soaring inflation, sluggish growth, and pervasive uncertainty (European Commission 2022). Large European economies like Germany and Italy’s dependence on Russian gas led to significantly higher energy-driven inflation compared to the US. European inflation surged to 10.6% in October, while the US experienced a relatively lower rate of 7.2%.
Research by Bobasu and De Santis (2022) further highlighted that the Ukraine conflict and the ensuing energy price surge significantly increased uncertainty within the Eurozone. This uncertainty negatively impacted GDP and domestic demand across the euro area. The energy crisis plunged the EU’s terms of trade to historic lows, making the euro’s depreciation against the dollar an almost inevitable consequence of the geopolitical turmoil.
Adding to the economic headwinds, some economists argue that the economic slowdown in China had a more pronounced impact on Europe than the US, further weakening the euro to USD exchange rate. Daniel Lacalle suggested that the Chinese slowdown exerted downward pressure on the euro area’s trade surplus, diminishing the euro’s ability to maintain its strength relative to the dollar.
Monetary Policy Divergence and the Euro to Dollar Exchange Rate
Another crucial factor driving the euro’s depreciation was the contrasting monetary policy stances adopted by the ECB and the Federal Reserve. The Fed adopted a more aggressive, hawkish approach to combat rising inflation, signaling its intention to raise interest rates as early as June 2021. The Fed initiated interest rate hikes in March 2022 and followed with subsequent, rapid increases. Conversely, the ECB maintained a looser monetary policy until July 2022, when it implemented its first interest rate increase.
This disparity in policy approaches led to a widening of interest rate differentials between the US and the Eurozone. Investors, seeking higher returns, shifted investments from European to American assets, driving up demand for the dollar and further weakening the euro to dollar exchange rate. Since the Fed’s initial rate hike announcement in June 2021, the dollar has appreciated by approximately 20% against the euro. Beckworth and Leeper (2022) suggest that the ECB’s more cautious approach might be influenced by the high levels of debt in some Eurozone economies. For a historical perspective on monetary policy challenges, see also von Hagen (1999).
The Safe Haven Appeal of the US Dollar and its Impact on EUR/USD
The perception of the US dollar as a safe haven asset, particularly during times of global crises, also contributed to the euro’s weakness. US assets, especially Treasury bonds, are widely considered safe havens, attracting investors during periods of uncertainty. This increased demand for dollar-denominated assets during turbulent times, such as the Ukraine crisis, naturally strengthens the dollar against other currencies like the euro. Egorov and Mukhin (2021) argue that the US, as the issuer of the dominant global currency, is better insulated from international economic shocks and can benefit from its global financial status.
The Ambiguous Benefits of a Weak Euro
A weaker currency can present a mixed bag of economic effects. Conventional economic theory suggests that currency depreciation should boost exports by making them cheaper for foreign buyers. Beck et al. (2022) found evidence that during exchange rate depreciations, large banks with significant foreign currency asset exposure increase lending to export-oriented firms, leading to higher output growth in regions with smaller banks.
However, the effectiveness of a weak euro as a stabilizer during the 2022 crisis was questionable. Supply chain disruptions and sanctions hindered European businesses’ ability to capitalize on price competitiveness and benefit from the lower real effective exchange rate (Colijn and Brzeski 2022). Furthermore, a weak euro makes imports more expensive, exacerbating already high inflationary pressures in the Eurozone (as highlighted by this DW article). This import-driven inflation can negate any potential export benefits. Economists like Mauro et al. (2017) point to the ongoing debate and lack of consensus regarding the sensitivity of exports to exchange rate fluctuations. Ahmed et al. (2015) even argue that global value chains have reduced the responsiveness of manufacturing exports to exchange rate changes. In contrast, Tsyrennikov et al. (2015) contend that there is still a clear link between exchange rates and trade flows.
Should the ECB Intervene to Strengthen the Euro to Dollar Exchange Rate?
The question of whether the ECB should actively intervene to strengthen the euro against the dollar is a subject of considerable debate. Lodge and Perez (2021) suggest that globalization has reduced the exchange rate pass-through (ERPT) to inflation in the EU, potentially making foreign exchange interventions less effective.
Question 1: What was the main cause for the euro’s decline relative to the US dollar in 2022?
However, a significant portion of international debt is denominated in US dollars. Gopinath and Gourinchas (2022) warn that a weakening euro could make debt repayment more challenging for the private sector, increasing the risk of financial distress. Conversely, Ethan Ilzetzki (Mercatus Center podcast) argues that high-income economies like those in the EU are better hedged against such risks, and a strong dollar could even improve the balance sheets of some institutions. Some experts also argue that the inflationary pressures exacerbated by a weak euro justify ECB intervention. Suggestions have even been made for a coordinated international effort, similar to the Plaza Accord, to weaken the dollar and strengthen currencies like the euro (Washington Post article).
To gauge expert opinion on these issues, the CfM-CEPR panel of experts on the European macroeconomy was surveyed regarding the causes of the euro’s 2022 weakness and the appropriateness of policy responses should euro weakness return.
Expert Opinions on the Euro’s Depreciation and ECB Policy Response
Question 1: Causes of the Euro’s Decline in 2022
A majority of the CfM-CEPR panel, 56% (or 61% when weighted by confidence levels), identified monetary policy differentials as the primary driver of the euro’s weakness in 2022. 29% attributed the decline to real economy factors.
Maria Demertzis (Bruegel) noted that the “real exchange rate [was not] different to historical values [in 2022]”, suggesting that “real factors or indeed the war in Ukraine” were not the dominant causes. Jagjit Chadha (National Institute of Economic and Social Research) proposed that the ECB’s “less aggressive response to emergent inflationary pressures and concerns about weak growth in the face of high levels of indebtedness may have acted to constrain the policy response.” Morten Ravn (University College London) highlighted “initial doubts about the ECB’s willingness to increase the policy rate in the face of ‘fragmentation risk’ and continuing credit policies.” Fabrizio Coricelli (University of Siena and Paris School of Economics) pointed to the euro’s recovery following ECB policy tightening in the second half of 2022 as further evidence that monetary policy differences were key.
However, almost a third of the panel emphasized real factors, particularly the Russia-Ukraine war. Omar Licandro (University of Nottingham) and Evi Pappa (European University Institute) cited Europe’s “high energy dependence” on Russia, especially “Russian fossil fuel imports,” as a major contributor. Jumana Saleheen (Vanguard Asset Management) attributed the depreciation to diverging growth expectations between the US and the Eurozone. She argued that fears of energy shortages crippling European industry, combined with the US experiencing a “positive terms of trade shock,” led investors to anticipate stronger US growth, favoring the dollar. Lukasz Rachel (University College London) also acknowledged the US terms of trade benefit but suggested “financial factors” might have played a more significant role, as proposed by Itskhoki and Mukhin (2022).
Paul de Grauwe (London School of Economics) offered a dissenting view, cautioning against oversimplification and “invent[ing] stories” to explain exchange rate movements, highlighting the inherent uncertainty in predicting currency fluctuations (Financial Times article).
Question 2: Should the ECB Respond to Euro to Dollar Exchange Rate Movements?
A strong majority (81%) of the panel believed the ECB should not respond to exchange rate fluctuations of the magnitude observed in 2022. Only 14% thought intervention was warranted, split evenly between unilateral and coordinated action.
The prevailing view was that the ECB should prioritize its inflation mandate. Andrea Ferrero (University of Oxford) stated, “The ECB should continue to focus on its inflation stability mandate and thus respond to exchange rate movements only insofar as inflation is affected.” Ethan Ilzetzki (London School of Economics) argued that the exchange rate movement was a natural correction as “Eurozone economies were running large current account deficits,” forcing necessary economic adjustments. Jürgen von Hagen (Universität Bonn) stressed that the ECB’s primary challenge is maintaining independence from political pressures, not managing the exchange rate. Cédric Tille (The Graduate Institute, Geneva) concurred that any ECB response should be driven by inflation concerns, not the exchange rate itself.
A small minority supported ECB intervention, with Richard Portes (London Business School and CEPR) suggesting unilateral intervention might be justified if depreciation threatened to significantly worsen inflationary pressures or financial stability. Jorge Braga de Macedo (Nova School of Business and Economics, Lisbon) advocated for coordinated intervention, citing the historical precedent and the need for international cooperation in the face of global economic and political challenges.
References
Ahmed, S, M Appendino and M Ruta (2015), “Depreciations without Exports? : Global Value Chains and the Exchange Rate Elasticity of Exports”, World Bank Policy Research Working Papers.
Beck, T, P Bednarek, D te Kaat and N von Westernhagen (2022), “The Real Effects of Exchange Rate Depreciation: The Role of Bank Loan Supply”, CEPR Discussion Paper 17231.
Beckworth, D and E Leeper (2022), “Eric Leeper on the Interactions of Fiscal and Monetary Policy | Mercatus Center”, podcast on www.mercatus.org, 4 April.
Bobasu, A and R De Santis, (2022), “The impact of the Russian invasion of Ukraine on euro area activity via the uncertainty channel”, ECB Economic Bulletin, Issue 4/2022.
Colijn, B and C Brzeski (2022), “Euro Weakness Is No Blessing in Disguise for the Eurozone”, ING Think, 17 August.
Egorov, K and D Mukhin (2021), “Policy implications of dollar pricing”, VoxEU.org, 19 November.
European Commission (2022), “Autumn 2022 Economic Forecast: The EU Economy at a Turning Point”, ec.europa.eu, 11 November.
Gopinath, G and P Gourinchas (2022), “How Countries Should Respond to the Strong Dollar”, IMF Blog, 14 October.
Itskhoki, O and D Mukhin (2022), “Sanctions and the Exchange Rate”, VoxEU.org, 16 May.
Lodge, D and J Perez (2021), “The implications of globalisation for the ECB monetary policy strategy”, Occasional Paper Series, No 263, ECB.
Mauro, F, J de Kerke and V Demian, (2017), “You need an ‘extra moment’ to assess the impact of the exchange rate’, VoxEU.org, 8 December.
Tsyrennikov, V, W Lian, M Poplawski-Ribeiro and D Leigh, (2015), “Exchange rates still matter for trade”, VoxEU.org, 30 October.
Von Hagen, J (1999), “A New Approach to Monetary Policy (1971-8)”, in Deutsche Bundesbank (ed.), Fifty Years of the Deutsche Mark. Central Bank and the Currency in Germany since 1948, New York: Oxford University Press, 1999.
