Weak Euro, Strong Dollar: What It Means for Fashion

Updated: Jun 1

By Business of Fashion

This article was published in Business of Fashion May 27, 2022. In May, the euro neared parity with the dollar for the first time in 20 years, reflecting a darkening outlook for Europe’s economy as well as moves to curb inflation in the United States.

Last week, the euro neared parity with the US dollar for the first time in two decades, dipping to as low as $1.04 after a year of steady declines.

Europe’s common currency has since regained some ground, reaching $1.07 on Friday morning. But many analysts are convinced the value of one euro could sink below one dollar by the end of the year.

The shift reflects a darkening outlook for Europe’s economy in the wake of Russia’s invasion of Ukraine, as well as a surging dollar as the US tightens monetary policy.

But amid the flux, a weaker euro and stronger dollar has some benefits for the largely Europe-based luxury sector, which could enjoy a boost to margins and an easier time selling to travellers from the dynamic US market.

Why Is the Euro Weakening Against the Dollar?

Since the Ukraine assault began in late February, the euro has fallen more than 5 percent against the dollar as European countries struggle to find alternatives to Russian oil and gas, a major problem if energy ties are severed.

At the same time, the US Federal Reserve is forging ahead with hikes to interest rates in a bid to slow the country’s worst inflation in 40 years, boosting the dollar’s value against many currencies even as the US economy looks increasingly at risk of recession.

None of those factors are good news for luxury brands, which depend on consumers’ optimism and sense of financial security to drive purchases of $10,000 Chanel bags and $1,000 Balenciaga sneakers: Luxury stocks have tumbled since the start of the year, with LVMH falling by 20 percent and Kering and Richemont both falling by around 30 percent.

Even as they reported surging sales in late 2021 and early 2022, the war in Ukraine and accelerating inflation, as well as concerns over coronavirus lockdowns in China, have clouded the sector’s outlook and dampened investor sentiment.

“We face a global environment which is the most unsettled we have experienced for a number of years… We face volatile times ahead,” Richemont chairman Johann Rupert said last week. It was a far cry from the heady mood of 2021, when a post-Covid rebound showed no signs of slowing at the sector’s top brands.

But a weak euro and strong dollar can benefit luxury companies for several reasons.

How Does a Stronger Dollar Impact the Bottom Line?

A euro that is weaker against the dollar will boost profit margins. Luxury brands are mostly European companies whose costs are largely in euros — from corporate salaries to manufacturing facilities to rents for flagship stores on Avenue Montaigne and Via Montenapoleone. At the same time, every sale made in the dynamic US market will be worth more when converted back into euros. (A similar dynamic applies to British luxury firms like Burberry, as the pound has also fallen against the dollar, and Swiss watchmakers following recent weakness in the Swiss franc, although the franc has recovered against the dollar in recent weeks).

For all their talk about “harmonising” prices across regions, brands are unlikely to pass the favourable exchange rate on to US-based consumers. Moves aimed at equalising prices across regions do occur, but usually only in one direction — up.

So the wider margins from a weak euro will provide welcome breathing room, offsetting the rising cost of materials and labour at a time when the sector’s outlook is increasingly unclear.

Brands use hedging contracts to help smooth currency risk, meaning many transactions are still being settled at the old, less favourable exchange rate, so the immediate impact could be limited. But no company hedges 100 percent of its transactions, and the longer a weaker euro lasts the more the sector will benefit.

“A weak euro is very good for [French luxury] companies’ bottom line,” Chanel’s chief financial officer Philippe Blondiaux said as the brand reported earnings this week.

What Is the Impact on Travel Retail?

The decline of the euro comes as international travel shows signs of finally rebounding from the pandemic. While key Chinese consumers remain largely grounded, Americans are returning to European capitals in droves, and seem to be more interested in luxury brands than ever. Luxury conglomerate LVMH saw sales in the US grow 24 percent above pre-pandemic levels last year. A weaker euro is likely to reinforce both these trends and incentivise Americans to shop while in Europe.

A Louis Vuitton bag that costs $2,030 in the US currently goes for €1,500 (or $1,602) in France. That’s a 21 percent savings. The gap widens to around over 30 percent when customers take advantage of a sales tax rebate of around 12 percent offered to foreign visitors by countries like France and Italy. (Declaring the bag upon return to the US could eat into those savings, although in the case of the $1,602 Vuitton bag, a couple would be allowed to pool their $800 per person exemption and slip by duty-free).

This kind of arbitrage makes shoppers feel like they’re getting a deal. For brands, many sales made to travelling customers are comprised of purchases they simply wouldn’t have made at home. “It’s really making the pie bigger,” a finance executive at one Italian luxury brand said.

The more appealing prices could also help bolster luxury brands’ appeal with aspirational shoppers feeling “priced out” following recent increases.

How Should Brands Respond to the Shift?

In order to take advantage of the emerging travel retail opportunity, however, the luxury industry will need to work harder to educate US consumers about tax-rebate services: the fact that duty-free shopping is permitted outside of airports is something many Americans don’t realise.

To be sure, the benefits of a weaker euro could be short lived: spiking energy and food costs since Russia’s Ukraine attack have caused inflation to reach Europe’s shores as well, and the European Central Bank could raise interest rates quicker than expected. On the other hand, the US could slow down its rate hikes as the risk of recession mounts. But analysts expect the euro to trade at $1.04 year from now, in line with Europe’s pattern of tightening monetary policy more slowly than the US, according to Trading Economics’ average estimate.

Luxury brands are also aware that a weaker euro comes with some risks. The price gap between the US and Europe could incentivise resellers, and eventually lead to a parallel market for luxury goods, as it did in China for years. That would undermine brands’ efforts to establish direct, regular contact with customers — a particularly pivotal objective with American customers, where brands are keen to hold onto surging ranks of new clients since the pandemic.

That risk remains muted, however, as most Americans are reassured of a product’s authenticity when they buy directly from brands — in addition to simply finding it more enjoyable. Plus, the country’s tightly-monitored entry ports and rule-following culture makes cheating customs and import duties a relatively fringe activity.

Brands worried about cannibalising their direct business in the US could also put an end to parallel trade simply by raising their prices in the eurozone. Euro weakness could create the “necessity to readjust our prices to avoid price gaps,” Chanel’s Blondiaux said.

Increased costs, and a desire to preserve a certain positioning relative to players like Chanel (which has aggressively increased prices) mean some modest price hikes could be on the horizon. But many have already pushed prices upwards since the pandemic, and with uncertainty on the rise drastic price hikes seem unlikely for the wider sector.

Most brands will simply be happy to see a renewed buzz on European shopping streets — which house some of their biggest, best-staffed and previously most-profitable points of sale — after years of pandemic travel restrictions.

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