[Global Focus] Euro Becomes Second Key Currency... Yet Far from Being a True 'Dollar Challenger'

[New Currency War] ④ Euro
Became the 2nd Key Currency but... Decline in Euro Payment Share
Political and Economic Instability in Eurozone... Rise of Chinese Yuan Also a Threat
Euro 'Parity' Collapse... Outlook for This Year

"Geopolitical fractures caused by the hegemonic competition between the United States and China are stimulating inflation and could threaten the status of the dollar and euro as key global currencies." (Christine Lagarde, President of the European Central Bank)

Following the US dollar, the position of the euro, considered a representative global key currency, is gradually becoming unstable. While the status of the dollar and yuan is rising amid US-China competition, the euro is losing its footing. Although it was launched 24 years ago with the dream of becoming a competitive key currency challenging the dollar, political and economic instability within the European Union (EU), the rise of China, and the still strong status of the dollar have led to assessments that there is still a long way to go.

Second Key Currency but... Decline in Euro Payment Share

According to the Society for Worldwide Interbank Financial Telecommunication (SWIFT), the global interbank payment network, the euro's share of international payment currencies was 31.7% last month. It is the second highest after the dollar, but its share is gradually decreasing. The euro's share in the international payment currency market fell from 37.5% in 2013 and 34.3% in 2018 to the 31% range this year (as of April). During the same period, the dollar's share rose from 35.6%, 39.2% to 42.7% last month. As a result, the gap between the dollar and euro payment shares widened from 1.9 percentage points 10 years ago to 11 percentage points currently.

Looking at the share of global foreign exchange reserves, the euro also falls far short of the dollar. According to the currency composition of official foreign exchange reserves released by the International Monetary Fund (IMF), the euro accounted for 20.5% in the fourth quarter of last year, only one-third of the dollar's 58.4%. In the foreign exchange trading market, the euro's share is also significantly lower than the dollar's. ECB President Lagarde expressed concerns about the euro's status as a key currency. At an event held by the Council on Foreign Relations in New York last month, she said, "The use of the Chinese yuan and Indian rupee in international trade is increasing, and gold reserves as alternative assets in foreign exchange reserves are rising," adding, "Some countries may reduce their dependence on the dollar and euro."

[Image source=Yonhap News]

Political and Economic Instability in the Eurozone... The Rise of the Chinese Yuan Also a Threat

The euro, launched as the official currency of the EU on January 1, 1999, has failed to replace the dollar partly due to the overwhelming influence of the United States, which possesses strong military and economic power, as well as political and economic instability in Europe.

Around 2010, the economic situation in Europe worsened, clearly revealing the limitations of the euro as a key currency. In particular, the European debt crisis, weakening leadership of Germany and France who led the EU, Brexit (the UK's withdrawal from the EU), and imbalances and conflicts among member states became obstacles. The widening wealth gap between Southern Europe and Northern/Western Europe, along with the EU's emphasis on strict fiscal rules, made it difficult for Southern European countries with high government debt ratios to pursue independent fiscal policies, which in turn fueled political conflicts among member states. From the perspective of monetary authorities, in a situation of significant economic imbalance within the region, even a slight interest rate hike could plunge heavily indebted Southern European countries into recession, narrowing the room for maneuver. Additionally, the COVID-19 pandemic and energy price volatility caused by the Ukraine war have become risks to the European economy.

The rise of the Chinese yuan challenging dollar hegemony has also threatened the euro. China is expanding yuan settlements in international trade with developing countries and gradually increasing yuan transactions in the oil payment market, which is dominated by the dollar. As the share of China's 'petro-yuan' grows, the yuan's payment share has gradually increased from 0.69% in 2013 and 1.66% in 2018 to 2.29% in April this year.

Adrian Schutte, Professor of Public Administration at Radboud University in the Netherlands, analyzed, "Considering the decline in economic power in the Eurozone, the increase in the global role of the euro is limited," adding, "The euro's share in foreign exchange reserves has changed little over more than 20 years, while other currencies' shares have expanded, indicating that the euro has little room for growth." Especially amid intensifying US-China conflicts, Professor Schutte argued that it is necessary to consider whether expanding the euro's influence is truly beneficial. He said, "The main global geopolitical competition occurs between the US and China," and added, "There needs to be a question of whether the EU desires to expand the euro's role at the expense of the US or focus on strengthening cooperation with the US."

Euro 'Parity' Collapse... Outlook for This Year

The euro is still considered unstable in terms of currency value stability, meaning it is highly volatile. Last year, when the US, holding dollar hegemony, embarked on a high-intensity tightening, the euro collapsed helplessly. When the US Federal Reserve (Fed) implemented high-intensity tightening last year, the euro fell below the 'parity' exchange rate (1 euro = 1 dollar), marking its lowest level in 20 years. However, on the 19th (local time), the euro closed at 1.0802 dollars per euro in the international foreign exchange market. Since the parity collapsed at 0.9941 dollars per euro on August 22 last year and hit a low of 0.9535 dollars on September 28, the euro has risen by 13.3%.

Market forecasts are divided on whether the euro will continue its strength after last year's hardships or shift to weakness this year. Generally, the market expects the euro to strengthen. US investment bank Goldman Sachs predicts the dollar's value will decline while the euro's value will rise. According to Goldman Sachs' analysis, the dollar is currently 5-15% overvalued relative to its fair value, while the euro is undervalued by 8%. The steady recovery of the Eurozone economy and persistently high inflation, which suggests the ECB will continue its rate hike stance for the time being, are also factors supporting the euro's rise. Amundi Asset Management forecasts the euro's value will rise to 1.18 dollars this year.

On the other hand, some view the euro's strength as likely to fade soon. This is based on the expectation that even if the Fed ends its tightening cycle, it will be difficult to cut interest rates within the year. Roberto Mialich, Forex Strategist at UniCredit, said, "The market is increasingly converging on our scenario that there will be no Fed rate cuts this year," adding, "This will delay the dollar's depreciation until the second quarter of next year." He further added, "It is highly likely that the euro's value will not exceed 1.1 dollars this year."