Euro’s rise not a threat to the recovery

The euro’s rise against the US dollar over the past few weeks has probably reflected speculation of ECB tapering, as well as perceptions of diminished political risk in the currency union. We doubt that these forces will be sustained, while we also expect the US Fed to tighten policy faster than investors currently anticipate. As a result, we think that the euro will weaken over the course of the year. That said, exchange rates are notoriously hard to predict. If the euro remains higher than we have assumed, export growth would probably be a little weaker than we forecast. But consumer spending growth might be stronger, as there would be less of a hit to households’ budgets from higher import prices. And if a stronger exchange rate reflected improved economic prospects, consumers might be more willing to raise their spending. The upshot is that euro’s current value is not a risk to the recovery. If it rose further though, it could become a problem.