There are two main reasons for the current weakness of the euro. One is the interest rate differential between the dollar and the euro, a gap that was temporarily contracting but is now widening again based on the extraordinary strength of the U.S. economy.
The other is investment in the U.S., which has still not fallen off amid the ongoing shift of funds from the euro to the dollar. In a nutshell, the euro is being undermined by the strength of the U.S. economy. So, if the U.S. economy undergoes an adjustment, will the euro bounce back strongly? The answer is no.
If inflation hits the U.S., it will break the theory of the new economy that preaches growth without inflation. However, if such a situation were to emerge in the U.S. at a time when the euro zone is displaying economic growth of more than 3 percent, inflation would also probably reach a dangerous level from the viewpoint of Germany, Europe’s largest economy.
This would likely result in the kind of discord over monetary policy that has not been seen since the debut of the euro, which pitted the German Bundesbank, an inflation fighter, against several countries whose priority was to stimulate economic growth. Based on experience so far, the discord would likely encourage market players to sell the euro.
What would also curb a sharp rebound by the euro is the political might of the euro zone countries. Since the European economy has been experiencing an export-led recovery so far, politicians have remained so silent on the weakness of the currency that they seem to have completely accepted it, unlike the European Central Bank.
However, European politicians have found that the introduction of the euro has considerably helped them recapture the ability to control currencies from the U.S.
They are likely to unify their efforts to prevent any rise in the value of the euro that would destroy economic growth in the region. This would be quite different from the individual moves that have been made by France and Germany so far, so one cannot make light of this power.
Thus, the euro will not return to the level it was given at its introduction.