The euro falls below the dollar, and gas is to blame

The euro fell below parity with the dollar in late August, to depths last seen two decades ago, and currency desks explained the move as a simple divergence in monetary policy, with a determined Federal Reserve outrunning a timid European Central Bank. That story is too tidy. Currency markets exist to clear the balance of payments, and the euro's slide is mostly the arithmetic of an energy import bill that has wiped out Europe's trade surplus and turned the continent into a net importer of capital.

For more than twenty years the euro zone ran as an export machine, using cheap pipeline gas and efficient industry to produce reliable current-account surpluses. That model broke when European Title Transfer Facility (TTF) gas contracts jumped towards €340 per megawatt-hour on 26 August. When an industrial bloc has to send tens of billions of euros abroad every month just to keep its power grids running, a weaker currency stops being a policy choice. It is the only shock absorber left.

Russia turns off the tap

The squeeze was applied in stages. Gazprom cut flows through the Nord Stream 1 pipeline to 40 per cent of capacity in June and to 20 per cent in late July, then halted them at the end of August for what it called maintenance, and has since said the line will stay shut. Every cubic metre that no longer arrives by pipe has to be replaced with liquefied gas bought on the spot market, priced in dollars and fought over with buyers in Asia. Germany, the bloc's industrial engine, recorded its first monthly trade deficit since 1991 in May.

How the money leaves

The mechanism is plain. A European utility buying a spot cargo of liquefied gas pays an American or Qatari seller in dollars, so it must sell euros to do so, and the bigger the bill the more euros hit the market. The same utilities hedge their power sales with futures on exchanges, and as prices spiked the margin on those positions ran into the billions. Germany agreed in July to rescue Uniper, its largest gas importer, and this month Finland and Sweden offered emergency liquidity guarantees to their power companies. A currency whose largest energy buyers need state credit lines to stay solvent has little to recommend it to foreign savers.

A cheap euro sells little

The slump in Europe's terms of trade works like a tax on the whole economy. In past cycles a falling currency steadied industry by making exports cheaper and lifting foreign demand for German machinery and French luxury goods. In 2022 exporters cannot take advantage, because their marginal costs are set by the same energy imports whose prices have soared.

A weaker euro does nothing for a chemicals maker in Ludwigshafen paying ten times what competitors on the US Gulf Coast pay for gas feedstock. The falling exchange rate simply raises the domestic price of imports priced in dollars, adding to imported inflation and to the squeeze on households' real incomes. The old pattern of export-led recovery has given way to a steady leak of European purchasing power through the balance of payments.

The losers are households paying dollar-priced energy out of euro wages and the energy-hungry industries, among them fertiliser, glass and aluminium, several of which have already curtailed output. The gainers sit outside the bloc. American LNG exporters are sending Europe cargoes that once went to Asia, Norway has overtaken Russia as the largest supplier of pipeline gas to the European Union, and American tourists find Paris cheaper than at any time in twenty years.

Frankfurt has few tools

The European Central Bank is stuck. Textbook doctrine says bigger rate rises can defend a currency by widening the interest-rate gap. But raising deposit rates in the middle of an energy crunch risks more insolvencies at home and produces not one extra cubic metre of gas. Higher rates will not restart pipeline flows across the Baltic Sea.

Frankfurt has tried anyway. The ECB raised rates in July for the first time in eleven years, by half a point, and followed on 8 September with a 75-basis-point increase that took its deposit rate to 0.75 per cent. That still leaves it well below the Fed's range of 2.25 to 2.50 per cent, and the gap in energy bills between the two economies dwarfs the gap in yields.

Tighter financial conditions also revive fears of fragmentation in the euro area's government bond markets. Wider spreads between Italian BTPs and German Bunds already limit how hawkish Frankfurt can afford to sound. The Transmission Protection Instrument exists on paper, and few central bankers would relish testing its triggers while also engineering a recession.

Governments are filling some of the gap with money, which carries its own currency risk. Germany unveiled a third relief package worth €65 billion on 4 September, and EU energy ministers met on 9 September to discuss a levy on the windfall profits of power generators and other emergency measures. Subsidies of that kind protect households but keep energy demand higher than prices alone would, so more euros keep flowing out to pay for imports.

Intervention did not work in 2000

The last time the euro sank this far, in its infancy, the rich world's central banks stepped in. In September 2000 the ECB, the Fed and their Group of Seven counterparts bought euros together, yet the currency still made its all-time low the following month and did not regain parity until 2002. Joint action is harder to imagine now, when a strong dollar is helping the Fed import disinflation and Washington has little reason to weaken it.

The strongest objection is that rate differentials still explain most day-to-day moves, and that the euro will rally once the Fed stops raising rates. That may govern the timing of any rebound. It cannot fix the level, because a narrower yield gap does nothing to shrink a gas bill paid in dollars every month.

The euro's floor will be set by the weather and by storage. The EU has agreed to fill its gas storage to 80 per cent by 1 November and asked member states to cut gas use by 15 per cent over the winter. Full tanks, a mild winter and a sustained fall in TTF prices would shrink the import bill faster than any rate rise, while a cold snap would do the reverse.

The euro will therefore follow Europe's energy balance more closely than anything said in Frankfurt. As long as Europe buys spot liquefied natural gas against Asian bidders, the euro will probably have to stay weak enough to force Europeans to use less energy and buy fewer imports. Until the continent finds another source of affordable baseload power, parity is a level the single currency will struggle to climb back above this winter, and energy-intensive manufacturers will carry the heaviest share of the adjustment.