Since most European oil imports are settled in dollars, the depreciation of the euro against the dollar will inevitably translate into higher oil prices in the European Union.
On Tuesday, the euro plunged to parity with the U.S. dollar for some time before it rebounded a little as a result of profit-taking by traders, the lowest level in nearly 20 years.
The depreciation of the euro, a single currency shared by 19 European countries, will add to upward pressure of rampant inflation in the euro area and is likely to heap pressure on the European Central Bank (ECB) to tighten at a faster pace or more aggressively.
The euro has been on a losing streak since the beginning of this year, which has lost around 12 percent of its value against the dollar, and the depreciation of the single currency is largely attributed to the dollar strength and the worsening economic growth prospect in the euro area.
The dollar has been gaining momentum since the Federal Reserve embarked on a tightening cycle in March. It has hiked interest rates for three times this year by 25 basis points, 50 basis points and 75 basis points respectively.
The increase of 75 basis points in June, the largest increment since 1994, came as a surprise to the market. The dollar has been appreciating against a wide range of currencies in the world. The U.S. dollar index, which measures its value against a basket of six peers, rose to 107.92, the highest point in 20 years. The depreciation of the euro has been blamed on gloomier economic outlook in the euro area, which is baffled by high inflation.
As the Russia-Ukraine conflict rages on, there has been growing concern about the possible cutoff of gas supplies from Russia to Europe, which, according to observers, means a disaster for industries in countries that are heavily dependent on Russian gas.
Since the majority of deals of imported petroleum in the European Union are settled in dollars, the depreciation of the euro against the dollar will thus inevitably translate into higher oil prices in the European Union.
According to the account of the ECB governing council meeting in June, oil prices had increased by 88 percent in U.S. dollar terms but by 111 percent in euro terms since May 2021. Although the exchange rate of the euro is not a direct policy target of the ECB, the persistent depreciation of the euro against the dollar has become a concern for the central bank which is trying to rein in the rampant inflation by normalising its monetary policies.
"The marked and persistent depreciation of the euro against the U.S. dollar, the currency in which oil imports were predominately invoiced, had tangible and immediate effects on inflation, and therefore on inflation expectations," said the meeting minutes.
The ECB has revealed that it would hike interest rates by 25 basis points in July and is open to a larger increase in September. Some hawkish members of the ECB governing council has already called for more forceful moves.
Robert Holzmann, the governor of Austria's central bank and an ECB governing council member, has suggested that the ECB should raise interest rates by 50 basis points in July if needed. If the inflation outlook does not improve, the ECB should hike the rates by 125 basis points by September, he noted.