RIYADH, 23 April 2007 — The euro has been rising to record levels against the dollar, the yen, the British pound and other major European currencies such as the Swiss franc. The euro’s charge has been due to strong euro zone economic data and hawkish comments from ECB (European Central Bank) officials about hiking euro interest rates.
The pound has gone past the $2 level for the first time in 26 years because of expected interest rate hikes by the Bank of England and the booming UK economy. The Swiss National Bank president also signaled the possibility of further rate hikes this year, further fueling its rise against the dollar. Among major currencies, only the Japanese yen has been falling against the dollar (despite a small strengthening this week). The strengthening of the dollar against the yen has been due primarily to a phenomenon known as “carry trade”, where investors sell borrowed yens for dollars and invest them in higher-yielding dollar assets. Weakness in the Japanese economy, reflected in a deflationary situation, has prevented the Bank of Japan from raising its interest rates from near zero, despite recent announcements.
Starting its life at $1.1789 on Jan. 4, 1999, the euro reached its lowest level of $0.8252 on Oct. 26, 2000 and its highest level of $1.3633 on Dec. 28, 2004. In the last six months, the euro has come up from $1.277 to $1.359 on April 19, 2007, close to its all-time high, and a 6.4 percent increase.
While the short-term impact of the euro’s movements are not great for any country including Saudi Arabia, over the longer term, it is expected to have an impact on inflation, imports, exports and the value of the riyal, and also “force” businesses and consumers to adjust. The actual impact, as a point of fact, is mitigated because consumers cut back demand for goods and services as prices rise and suppliers also switch their sourcing to cheaper places (e.g., dollar or yen denominated products). This switching takes time, hence, the longer-term impact is greater than in the short-term.
In the short-term, the rise of the euro against the dollar will likely cause more harm to the profits of importers than the pocketbooks of consumers. With the dollar hitting a 2007 low of more than $1.35 to the euro on Friday, goods imported from Europe will cost more, but merchants will try, at least initially, to keep prices steady and let their margins shrink in order to remain competitive.
Prices of foodstuffs will not be affected by the euro’s rise because Saudi Arabia does not import many food items from Europe. The appreciating euro will more likely lead to hikes in the prices of European luxury items such as expensive watches, designer apparel and perfumery, electronic goods such as computers and televisions, European automobiles, particularly, the luxury brands, European vacations and medical treatment in Europe, etc.
One of the sectors most sensitive to the euro’s climb is the automotive industry, with the traditionally strong market for German luxury brands. However, this impact is being mitigated as some cars manufactured in Europe are invoiced in dollars to dealers here.
Moreover, the cheaper yen and dollar are making Japanese and American brands more attractive, thus, capping European car prices.
The falling dollar could, however, benefit some local traders, because Saudi exports — priced in dollars — will be cheaper in Europe. Potential beneficiaries of the soft dollar should be Saudi exports to Europe in petrochemicals, local pharmaceuticals, etc. European visitors to Saudi Arabia, particularly Umrah tourists, will also benefit.
(Khan H. Zahid is chief economist and vice president at Riyad Bank. He is based in Riyadh.)