Euro vs Dollar : Economic Factors
A world where the Euro vs dollar surpasses the US currency as the major
currency
would represent a major change from the status quo, and yet the Euro has
now become the reserve currency of choice by many of the major banks.
The European economy is second in size only to that of the US, and represents 22% of the world's total gross product with a working population that is the third largest in the world. The European Central Bank has responsibility for maintaining liquidity, purchasing power, overall stability, and for setting interest rates in order to maintain economic order.
The ECB board meets on a twice monthly basis, to discuss monetary policy and to set rates accordingly. The recent strength in the Euro has not been as a result of economic strength in Europe, but more to do with economic weakness in the USA. So what are the major factors which can affect the euro vs dollar currency pair. Let's take a look at two of the more important economic indicators, interest rates and GDP, and what happens to the euro vs dollar as a result.
Euro vs Dollar : Interest Rates
The first one
which we are all aware of, and affects us directly are interest rates. The central
banks of most developed countries use interest rates as a blunt
instrument with which to control both inflation, and the broader economy.
From a trading or investing perspective interest rate policy is a key
driver of currency prices. In simple terms if a country decides to raise
it's interest rates, then the currency of that country will strengthen,
since the higher rates will attract more foreign visitors. So taking the
example of a European resident invested in euros, if they decided to
invest in US treasuries, then they must sell euros and buy dollars in
order to purchase the bonds. If you believe that interest rates in the
US will rise in the longer term, then you are confirming your belief by
opening a long position in the US dollars.
If your view is that the US Fed is unlikely to raise US rates further, then you could back this view by buying a currency or assets in a country with a higher rate, or one where you believe higher rates are likely to follow in the short to medium term. If for example you believe that rates may fall in the US, but rise in the Eurozone, then for the euro vs dollar, this could drive investors to buy euros and sell US dollars.
Interest rates also create differentials between countries which allow speculators to profit from the carry trade. The currency speculator borrows money in a low interest rate country, and then buys assets in a country with a higher yielding interest rate, generally investing in assets such as bonds, resulting in significant flows of money from the low interest country to the higher. The carry trade appeals because of the returns available, particularly if invested in bonds. Many countries with low interest rates suffer from currency speculation, which in turn affects the strength or weakness of the currency. The euro vs dollar is less significant in this respect since the differential is relatively small at present.
Euro vs Dollar : Gross Domestic Product ( GDP)
GDP is a classic lagging indicator and foremost in reporting on the health of the
economy. In simple terms, it measures how fast or slow the economy is
growing. As a forex trader you need to monitor this
figure closely for signs of slow down or growth. GDP is the total sum of goods and services
made in the period and includes both items sold, and
those items yet to be sold i.e. stock. The market is very sensitive to
these figures, but it is the longer term trend that is important, so we
need to compare trends in GDP over the last years for a comparative and
meaningful analysis.
When the actual GDP figures are released the first question everyone asks is - "How does this compare with expectations ?" If the figures are below those expected or forecast by the economists, then the bond market is likely to react positively. Conversely if the figures are above, then bonds may suffer as inflation pressure looms with the possibility that the Fed will intervene sooner or later, and raise rates. To foreign investors a strong economy is viewed more favourably than a weak one. A robust economy will fuel demand by foreign investors in the stock markets and from higher yielding Treasury bills, which in turn will increase demand for the currency. However, it is not always this clear cut. If the central bank move more slowly in raising rates, then inflation could accelerate, lowering competitiveness and weakening the currency.
GDP figures affecting the Euro and the dollar are released on a quarterly basis, and as I said earlier, how these figures affect the currency pair will depend on many factors, not least of all, how they compare against forecast, but also how they compare with each other. In simple terms its the euro vs dollar!! The key thing is to consider what effect the numbers will have on the flow of currency between the two countries, and to what extent trader, investors and speculators will view the numbers and hence their long term view on the strength or weakness of one currency compared to another.
I am currently writing several other sites which look at other aspects of economic indicators which affect the euro vs dollar currencies and their relative strength or weakness to each other, so please check back regularly.