This year’s turbocharged run has taken the U.S. dollar to the verge of another historic milestone: parity with the British pound. In plain words, it becomes more likely that 1 British pound will be worth merely $1 for the first time in history as early as this year.
The pound’s depreciation reflects the euro’s downfall, which just experienced dollar parity for the first time in twenty years. The unified currency, which is 23 years old, has fallen further as worries of a recession in the eurozone rise amid an oil crisis primarily exacerbated by the conflict in Ukraine.
Other major currencies have also been negatively affected. This year, the Japanese yen has fallen over 20% versus the dollar, reaching its lowest level since 1998. After surpassing 80 rupees per dollar for the first time earlier this year, the Indian rupee fell to a new record low level on Monday as global investors flee riskier developing market assets.
Since the 1980s, the dollar has been undergoing its greatest value overshoot. In the face of severe volatility, a worldwide chorus of unease accumulates.
Why is the dollar gaining value?
A crucial aspect is the dollar’s reputation as a safe refuge in times of economic turmoil. In recent weeks, recession fears have surged, particularly in the eurozone, as global central banks aggressively restrict their money supply in response to soaring inflation, driven mainly by increasing energy and food costs. Investors are bolting to the relative safety of the U.S. dollar, which is now less exposed to some of the most significant global threats.
The Federal Reserve’s relentless interest rate rises are another cause. The Fed has been aggressively tightening monetary policy to curb surging inflation. The Fed’s aggressive posture contrasts with that of the Japanese central bank, which has maintained ultralow interest rates, and the European Central Bank, which has for the most time avoided sharp rate increases. This has widened the interest rate difference between the United States and the eurozone, encouraging investors seeking greater returns to shift their funds to the United States.
The most recent dollar appreciation versus the pound occurred after the British government announced the largest tax cuts in fifty years, with British Finance Minister Kwasi Kwarteng predicting more tax cuts. The government’s budgetary generosity has fueled fears that the Bank of England may increase interest rates even more aggressively.
Low growth is not the United Kingdom’s immediate concern. The external balance is significantly negative and dependent on foreign financing. The recently-announced significant fiscal expenditures may increase GDP somewhat in the near run. However, the more substantial concern is who will pay for it.
What is the impact of a high dollar on consumers?
An inflated currency adds to the hardships of consumers and businesses already struggling with rising expenses. A weak currency would increase the cost of imports denominated chiefly in dollars. When these commodities are raw materials or intermediary goods, their increased prices might contribute to a further increase in local prices. For visitors heading to the United States, this would significantly devalue their local currency.
A weak currency is typically considered beneficial for exporters and export-heavy countries since it makes exports cheaper in dollar terms, boosting exports. Amid interruptions in global supply chains, sanctions, and the conflict in Ukraine, this is unlikely to provide much relief.
Even for Indian consumers, the high dollar is a source of suffering. India is highly dependent on imports of crude and edible oils, which are priced in dollars and have grown pricey in rupee terms.
Expensive imports accelerate inflation, compelling central banks to seek an even more aggressive monetary policy to curb demand. High interest rates would raise the cost of mortgages and other loans.
On the other hand, when imports become cheaper in dollar terms, expenses for U.S. consumers and companies may decline. For American tourists visiting Europe, the dollar would be far more valuable. U.S. enterprises that do a significant amount of business overseas will be harmed if the dollar worth of their foreign earnings decreases.
‘An unfavourable atmosphere’
A rising dollar portends difficulty for developing economies, notably Turkey, Argentina, and Ghana, which have substantial dollar-denominated debt. Some of these nations may no longer be able to afford to pay their debts if the dollar appreciates.
This is a generally bad climate for developing markets; however, country vulnerabilities vary greatly. The good news is that in many of the largest EMs [emerging markets], dollar loans are pretty modest, and currency fluctuations have not been very significant. The dangers are concentrated in frontier countries like Sri Lanka (where these risks have already crystallised) and Ghana, in addition to the typical suspects such as Argentina and Turkey.
For import-dependent nations, a high dollar will increase inflationary fears. It will also diminish their vital dollar reserves, making it impossible for them to pay for imports.
When will the dollar’s ascent cease?
A “necessary condition” for the dollar advance to halt is a “definitive high” in inflation risk that prompts the Federal Reserve to pause its aggressive tightening cycle.
Additional variables, such as a peak in energy uncertainty in Europe and a transition away from zero-COVID in China, which continue to disrupt supply chains and contribute to the global downturn, would be required.
Some of these must occur to reduce the enormous influx of safe-haven funds into the United States. Policymakers are concerned that none of these components has fallen into place yet.