After an exceptional previous week, the pound was barely holding its ground against the euro as trading started on Sunday evening. Last week the pound soared 3.5% over the euro as investors cheered news that the Bank of England (BoE) could look to raise interest rates as soon as November. Sterling peaked at €1.1395 on Friday, its highest level in 2 months, before easing back to finish the week at to €1.1373.
|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.
On Thursday last week, the BoE surprised markets by saying that it could tighten monetary policy in the coming months, unless economic data suddenly takes a turn for the worse. This new eagerness to raise interest rates was then cemented by BoE policy maker Gertjan Vlieghe, who is considered one of the most conservative of the monetary policy committee. Vlieghe backed the BoE’s aggressive turn, by saying that a rate rise could be necessary in the coming months. These comments from the central bank’s least aggressive policy maker were enough to send the pound to an 8 week high versus the euro.
|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.
This week the focus is expected to shift away from central bank policy and firmly back to Brexit. UK Prime Minister Theresa May is due to give a speech on Friday in Florence, Italy where political analysts believe she’ll lay out her vision for Brexit. In this vision, May is expected to speak in favour of a smooth, transitional Brexit, which could help boost the pound.
|Why is a smooth Brexit good for the pound?
|A smoother Brexit would be a scenario in which the economic consequences of leaving the European Union are minimised. This is favourable for the pound because the less the Brexit impact on the economy, the more likely that foreign investors will remain interested in the UK. Foreign investors need sterling to invest in the country and so the more GBP is purchased, the higher the demand and, thus, an increase in the currency’s value.
Last week was a relatively quiet week for the euro as far as high-impact economic data was concerned. As a result, the euro drifted lower. However, today the euro could receive an injection of volatility as investors look towards inflation data for the eurozone. Inflation, as measured by the consumer price index, has struggled in the EU over recent months. This has caused concern among European Central Bank (ECB) policymakers who have said that they would prefer inflation to move closer towards the ECB’s 2% inflation target before the central bank raises interest rates. Analysts are forecasting inflation to be 1.5% in August, which would be an increase from July’s 1.3%. However, it’s unlikely to be sufficient to considerably change the ECB’s preference towards low interest rates and economic stimulus in the form of bond buying.
This article was initially published on TransferWise.com from the same author. The content at Currency Live is the sole opinion of the authors and in no way reflects the views of TransferWise Inc.