• Reason behind sharp Euro Depreciation

    The world’s second highest reserve currency after US Dollar, Euro has depreciated nearly 10% in last 4 months from its highest level (1.4487 USD per euro on August 29 which means 1.4487 USD needed to buy one euro) of this year and touched the lowest level of 1.2993 USD per euro on 14th December. The euro continues to struggle amid the current euro zone debt crisis which has put a big question mark on the existence of the currency in future.

    Since its inception in 1999, euro currency has been used as the main currency by 17 euro zone nations. Very soon it was recognized as the second mostly used, traded and reserved currency in the world. But recently Euro has lost its shine due to the current euro zone sovereign debt crisis. The Euro movement against USD for last 4 months is shown in the below graph.

    This steep euro depreciation was completely because of lower demand of Euro with higher demand of USD in the worldwide foreign exchange market. Now we will check the main reasons behind this euro depreciation one by one.

    1. Euro losing its credential: Current euro zone debt crisis which is worsening day by day by more credit rating downgrades and increasing sovereign debt crisis has put its own currency euro’s credibility in doubt. If Greece moves out of Euro zone, it will be a disaster for the currency. This fear is prompting worldwide central banks and investors to sell Euros in the currency market, thus increasing supply.
    2. Lower Demand of Euro: Investors’ confidence level in euro zone sovereign bonds has dropped to the record low level due to increasing crisis and continuously rising borrowing cost. Now they fear of losing investment value in those government bonds. Rather they now prefer investing in bonds of other countries like USA, Swiss, Australia, and China etc. Lower demand of euro zone sovereign bonds has decreased the demand of euro.
    3. High liquidity supply by ECB: European Central Bank has kept interest rate at low level and has been pumping euros to boost economic and industrial activity in the region. Higher supply has reduced its value in the forex market.
    4. Higher demand of USD: All the investors are now scrapping euro as reserve currency and rushing to invest in US Dollar dominated investments amid the current euro zone sovereign debt crisis. There are high demands of US securities among the worldwide investors and financial institutions even after the recent US credit rating cut. This higher demand of US Dollar has led to very low supply of USD in the worldwide foreign exchange market.

    Because of these reasons, there are high supply and lower demand of euros in the forex market which is continuously pushing its value down. Euro will continue to depreciate until there is a progress in resolving euro zone debt crisis and increase in optimism about the credibility of the currency.

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