The pound weakened on Monday against the euro as investors digested comments by Bank of England (BoE) Governor Mark Carney in addition to eurozone inflation data. The pound euro exchange rate dropped by 0.65% for the pound. Falling below the psychological level of €1.1300. However, despite the pullback, the pound has managed to hold onto the majority of its gains from last week.
|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.
Investors listened intently as BoE Governor Carney gave a speech at the IMF in Washington. Carney reiterated the prospect of “some withdrawal of economic stimulus” over the coming months in order to bring inflation back towards the central bank’s target level of 2%. However, he also went on to warn that the pace of interest rate rises would be gradual and limited. This was interpreted negatively by pound investors. As a result, the pound sold off.
|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.
The UK economic calendar today is sparse. Therefore, Brexit headlines could continue to impact on the pound as investors look towards UK Prime Minister Theresa May’s Brexit speech on Friday. There are rumours circulating that Theresa May will offer £30 billion to the EU as part of the divorce process in order to get the negotiation ball rolling once more. This is at the lower end of figures that analysts had put the divorce bill cost at. Therefore, the number is most likely to be rejected by the EU, which could cause some volatility for the pound heading into the weekend.
The euro rallied as it received some much-needed good news. Inflation in the bloc matched analyst’s forecasts at 1.5% in August growth from last year. This is the highest eurozone inflation level in the last 4 months and is a reasonable jump from July’s 1.3%.
However, the figure still remains well below the European Central Bank’s (ECB) 2% target inflation level. So, although it’s a step in the right direction, the ECB is unlikely to be looking to raise interest rates in the immediate future. Furthermore, the ECB believes that inflation will fall again next year to just 0.9%. With this in mind, the euro rally may be limited.
Today investors will look to the German ZEW sentiment data for clues. The data is expected to show that economic sentiment increased in Germany in August from 10 to 12. Should the data come in better than expected, then the euro could rise further.
|Why does strong economic data boost a country’s currency?
|Solid economic indicators point to a strong economy. Strong economies have strong currencies because institutions look to invest in countries where growth prospects are high. These institutions require local currency to invest in the country, thus increasing demand and pushing up the money’s worth. So, when a country or region has good economic news, the value of the currency tends to rise.
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.