Euro Drops Versus Pound as Merkel's Party Looks to Form 3 Party Coalition

The pound euro exchange rate kicked off the week in a volatile fashion. Investors were grappling with the news that German Chancellor Angela Merkel was headed for her fourth term, although her party’s performance was the worst it’s been since 1949. The euro sunk against the pound in a knee -jerk reaction to the news. As a result, the pound euro exchange rate is now trading 0.4% higher for the pound at €1.1340, as it continues to hover around recent 2 month highs.

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.

Following a key speech from UK Prime Minister Theresa May last week, the pound had eased back slightly following her comments about Brexit. Although the speech provided clarity in some areas, it provided no clarity in others. However, if the aim of the speech was to kick-start stalled negotiation talks, then it might well have been just enough. Still, it may fall short of allowing talks to progress to the second phase of negotiations; which includes discussing the future relationship between the EU and the UK.

Overall, however, the speech offered little fresh substance, which is why the pound slightly dropped following the speech. Brexit negotiators will travel back to Brussels today and attempt to flesh out May’s constructive shift, hopefully aiming towards a smooth Brexit – which will be pound-positive.

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.

Euro declines as Merkel’s Power Weakens

The euro dropped sharply on the day’s open following the German election results. Angela Merkel won for the fourth time, but her party’s margin was smaller than the polls’ forecasted figure of 32.5%. Germany’s far-right political parties also performed much better than expected. Winning over 13% of the votes, the party took seats in Parliament for the first time since the WWII.

As expected, because Merkel’s party didn’t win a large enough majority, a coalition will need to be formed. The overriding concern for the euro now is what type of coalition Merkel’s party and the Christian Democratic Union (CDU) will manage to form. The second largest party, the Social Democratic Party (SDP ), has already said that they will remain as opposition. Meanwhile, smaller parties like the Green Party and the Free Democratic Party (FDP) have said they are willing to talk with the CDU. Should this momentum remain, a coalition could be formed fairly quickly between the CDU, FDP and Green party. Rapid progress in the coalition formation process will calm jittery investors and could offer support to the euro.

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