Despite the European Central Bank (ECB) loosening monetary policy again last week, the euro finished higher versus the dollar. The euro US dollar exchange rate closed at US$1.1075, up 0.4% across the week. This was the second consecutive week of gains. The dollar is heading higher versus the euro in early trade on Monday.

What do these figures mean?
When measuring the value of a pair of currencies, one set equals 1 unit and the other shows the current equivalent. As the market moves, the amount will vary from minute to minute.

For example, it could be written:

1 EUR = 1.12829 USD

Here, €1 is equivalent to approximately $1.13. This specifically measures the euro’s worth against the dollar. If the U.S. dollar amount increases in this pairing, it’s positive for the euro.

Or, if you were looking at it the other way around:

1 USD = 0.88789 EUR

In this example, $1 is equivalent to approximately €0.89. This measures the U.S. dollar’s worth versus the euro. If the euro number gets larger, it’s good news for the dollar.

 

The euro was broadly in favour across the previous week, even after the ECB loosened monetary policy. The central bank cut the overnight deposit rate and restarted its bond buying programme, known as quantitative easing. These stimulus measures ensure that more euros are moving around the system, decreasing the value of the euro. However, the ECB is also upping pressure on individual governments to increase fiscal stimulus. This form of stimulus is inflationary and there underpinned the euro.

There is no important eurozone economic data to be released today. The euro could come under pressure on ahead of the release of the ZEW economic sentiment data on Tuesday. There was a sharp deterioration in economic sentiment in August. Investors will be wary of another drop in sentiment this month, particularly surrounding exporter nation Germany, as the US-China trade dispute drags on.

All Eyes To Wednesday’s Fed Rate Decision

The mood towards the dollar soured across the previous week despite mixed data and as relations between the US and China appeared to improve slightly.

US core inflation jumped in August at the fastest pace in a year. US retail sales also impressed. However, an underlying gauge of consumer grew at the slowest rate in 6 months, unnerving investors.

The Federal Reserve will meet this week and make their monetary policy announcement on Wednesday. Despite the stronger core inflation and headline retail sales, analysts broadly expect the Fed to cut rates, as a result the dollar has declined.

Why do interest rate cuts drag on a currency’s value?
Interest rates are key to understanding exchange rate movements. Those who have large sums of money to invest want the highest return on their investments. Lower interest rate environments tend to offer lower yields. So, if the interest rate or at least the interest rate expectation of a country is relatively lower compared to another, then foreign investors look to pull their capital out and invest elsewhere. Large corporations and investors sell out of local currency to invest elsewhere. More local currency is available  as the demand of that currency declines, dragging the value lower.

 

Investors could look towards the dollar today for its safe haven properties as tension rise in the middle east. Over the weekend Saudi Arabia experienced an attack on its oil infrastructure. The price of oil has surged as the markets opened after the weekend.

The US say that the attacks were orchestrated by Iran and has raised geopolitical risks. The US says that it is “locked and loaded” if Iran was behind the attacks. In times of increased geopolitical uncertainty investors tend to buy into the dollar; the world’s reserve currency.

 

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