Pound Charges Higher Versus Euro as BoE Coming Closer to Hiking Rates

The pound euro exchange rate is pausing for breath after rallying from a low for sterling of €1.1355 to a €1.14475 on pound strength. The exchange rate dropped dramatically on pound weakness following the UK general election a week ago. Whilst it is slowly regaining ground, the pound euro exchange rate still remains at least 0.8% off its pre-election levels.

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 GBP = 1.13990 EUR

Here, £1 is equivalent to approximately €1.14. This specifically measures the pound’s worth against the euro. If the euro amount increases in this pairing, it’s positive for the pound.

Or, if you were looking at it the other way around: 1 EUR = 0.87271 GBP

In this example, €1 is equivalent to approximately £0.87. This measures the euro’s worth versus the British pound. If the sterling number gets larger, it’s good news for the euro.

Sterling charged higher on Thursday after the Bank of England (BoE) Monetary Policy Committee (MPC) shocked investors by voting 5-3 to keep interest rates on hold. Five members of the committee voted to keep the interest rate at its current level of 0.25%. Three members voted for an increase in the interest rates level by 0.25%. The market had been expecting the vote to be 7-1, an assumption that the MPC would vote nearly unanimously for a stay in rates.

Why does this matter? In the eyes of the market, the more committee members that vote for a rate rise, the sooner a rate rise is expected to come. As interest rate expectations increase, the currency’s worth increases. Two more members voting in favor of a rate hike than expected explains the rally in the pound.

Why do raised interest rates boost 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. Higher interest rate environments tend to offer higher yields. So, if the interest rate or at least the interest rate expectation of a country is relatively higher compared to another, then it attracts more foreign capital investment. Large corporations and investors need local currency to invest. More local currency used then boosts the demand of that currency, pushing the value higher.

However, in reality, the BoE is in a tough position. Inflation is at almost 3% but consumers are reining in spending as wages fail to keep pace with the cost of living. The majority of the committee members fear raising rates will crush economic growth and so therefore it is better to allow inflation to continue to tick higher. Immediately after the release of the MPC’s decision, the pound jumped 0.8% higher versus the euro.

Eurozone inflation data in focus

Meanwhile, euro investors will be watching today’s eurozone inflation data intently. Bloomberg analysts are expecting eurozone inflation, in the form of the consumer price index (CPI), to be 1.4% annually in May, the same level as April. Economic indicators across the eurozone have been impressing for much of the year and pointing to a strengthening and growing economy. However, inflation is refusing to budge higher. The European Central Bank has clearly stated that they want to see indicators that inflation is steadily rising and closer to the central bank’s 2% target before they will consider tightening monetary policy.

Should inflation fail to reach the anticipated level of 1.4%, then interest rate expectations would decline and the euro could weaken further against the pound as the weekend approaches.

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