Commerzbank’s Thu Lan Nguyen discusses political concerns about Euro strength if it increasingly replaces Dollar as global reserve currency. She notes the Eurozone’s current account surplus could drive sustained appreciation, but past periods combined a strong Euro with respectable growth. Nguyen argues that if EU leaders accept a stronger Euro, markets may see further medium-term EUR/USD upside.

Reserve currency debate and Euro strength

"From the French government's point of view, the main problem is likely to be that, unlike the US, the eurozone has a current account surplus. Increased use of the euro in international payments would naturally increase demand for the single currency. However, the current account surplus would cause the eurozone economy to continuously suck euros out of the rest of the world, thereby reducing supply and causing the euro to appreciate significantly."

"An important question that arises is how painful it would be if the current account surplus in the eurozone were to decline significantly, possibly on a permanent basis. A look at the past shows that the current account balance has not always been significantly positive. In the 2000s, it was almost balanced for most of the time and even slightly negative at times."

"What is interesting is that the euro was strongly valued during this period. I use the deviation of the EUR-USD exchange rate from purchasing power parity as a measure. From 2003 to 2009, the euro was on average almost 20% overvalued against the US dollar on this basis."

"Nevertheless, this phase could allay some politicians' fears of an overly strong currency. If it becomes increasingly apparent that EU leaders are willing to accept a stronger euro in the medium to long term, this would be a green light for further euro strength from the market's perspective."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor.)