1 euro is now worth 1 US dollar for the first time in 20 years

LONDON (BLOOMBERG) - The euro has suffered a swift and brutal slump this year, and now it has crossed a major threshold for the first time in more than two decades: parity with the US dollar.

The 12 per cent decline is the result of multiple pressures, from the war in Ukraine to an energy crisis and the growing risk that Russia cuts off gas exports and pushes the euro area into recession.

Add in central banks moving at vastly different speeds and an in-demand dollar, and some analysts say parity may not be the end point, but merely a stepping stone to further weakness.

The common currency slipped as much as 0.4 per cent on Wednesday (July 13) to touch a low of US$0.9998.

The latest leg lower came after US inflation accelerated in June by more than forecast, boosting bets on Federal Reserve rate hikes. It bounced back to trade at around US$1.002 as at 2.10pm in London.

The downward spiral has not been accompanied by the type of existential doubts that hung over the euro when it plunged during its infancy in the early part of this century, or when the sovereign debt crisis took hold a decade ago.

However, it is still a problem for the European Central Bank (ECB).

It is also trouble for consumers in the €12 trillion (S$17 trillion) economy, feeding an inflation spike that is already out of control, with prices rising at a record pace close to 9 per cent.

The depreciation has been incredibly rapid, given that the euro was trading close to US$1.15 in February.

It is all the more remarkable given that less than two years ago, ECB policymakers were concerned about excessive euro strength leading to an inflation undershoot.

Now they confront a different world: a dramatic plunge in their currency and consumer prices surging.

Some ECB policymakers have already signalled that the weakness is on their minds, particularly when it comes to imported inflation.

Earlier on Wednesday, ECB policymaker Francois Villeroy de Galhau said the central bank is watching the euro's drop because of its effect on consumer prices.

In addition to the dual inflation-recession threat, the ECB is also dealing with the risk of sovereign borrowing costs diverging too much as it reverses course on stimulus.

After Italian yields spiked last month, the Frankfurt-based institution began work on a tool to prevent the eruption of another debt crisis in the region.

The euro's descent this year is just one part of a global story of dollar dominance.

The greenback has been in favour this year as a haven investment, helped by higher US interest rates. There has also been speculation that the rally could spur global policymakers to intervene to weaken it at some point.

At a meeting in Tokyo on Tuesday, US Treasury Secretary Janet Yellen and Japan's Finance Minister Shunichi Suzuki said that volatile exchange rates pose a risk, and pledged to consult and "cooperate as appropriate on currency issues".

The yen has declined to its weakest against the dollar since 1998.

The single currency, meanwhile, has particularly suffered because of Europe's proximity to the Ukraine war and its reliance on energy imports from Russia.

Monetary policy is also a driving force, given that the ECB has been slow to join the kind of aggressive policy tightening deployed elsewhere.

At the same time, increasingly large Federal Reserve interest rate hikes have supercharged the dollar, and created a rate differential that will keep the pressure on the common currency.

Nomura International strategist Jordan Rochester is already targeting further pain with a drop to 95 US cents. Citigroup sees it sliding below that level if Russia cuts off gas exports to Europe.

The euro "remains effectively unbuyable this summer", Mr Kit Juckes at Societe Generale said earlier this month.

The euro, now the currency for 19 countries and around 340 million people, has had many ups and downs since it began in 1999.

A bout of weakness in its early days pushed the currency below 85 cents against the dollar and led to questions about its viability and even dire predictions of its demise.

Back then, the ECB's first president Wim Duisenberg said the exchange rate is "not a target".

That is a refrain that has been repeated by policymakers through subsequent bouts of weakness or volatility.

Still, that did not stop the central bank, along with the US, Britain and others, making a surprise intervention to boost the euro in 2000.

The euro's initial slump gave way to a period of appreciation, with the currency at one point reaching US$1.60 in 2008.

That strength was seen as damaging to the economy, and euro-area politicians blamed it for hurting companies. Among those voices was France's finance minister at the time, Ms Christine Lagarde.

The euro weakened again as the global financial crisis took hold in 2008, and then entered a period of volatility as Europe's sovereign debt crisis wreaked havoc.

Once again, the euro's future was in doubt amid soaring sovereign borrowing costs, bailouts for indebted nations, a recession and record unemployment.

It was at that time that then ECB president Mario Draghi compared the euro to a bumblebee - a "mystery of nature" that should not be able to fly, but can.

Once the worst of that episode passed, the ECB continued with stimulus, limiting the currency's upside.

Then, starting in mid-2021, the euro began a steady slide downward towards parity.

While the ECB could hike more aggressively to buoy the euro now - a rationale governing council member Robert Holzmann has used to justify a half-point rise - its agency may be limited by the darker economic outlook.

In a Bloomberg survey this month, economists put the risk of a euro area recession at 45 per cent, up from 30 per cent in June. "No doubt the ECB will be quite concerned by the move, especially if it develops into a 'sell the euro zone' mentality," said ING Groep strategists led by Mr Chris Turner.

"Yet, faced with the looming risk of recession - and the euro being a pro-cyclical currency - the ECB's hands may be tied in its ability to threaten more aggressive rate hikes in defence of the euro."