Pound Back Above 1.14 Versus Euro on German Election Fallout

The fallout from the German election results continued to weigh on the euro on Tuesday. As a result, the pound euro exchange rate took another step higher for sterling, pushing through €1.14 once more. The pound now continues to trade at its strongest level versus the euro since mid-July.

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.

Brexit headlines have been the central focus for pound traders so far this week. The EU has rejected the UK Prime Minister Theresa May’s request for fast-track talks on Brexit transition deal. Instead, the EU Chief negotiator is standing firm that issues such as the divorce bill, EU citizen’s rights, and Ireland’s borders must be dealt with before progressing to the next phase, which includes any transition deal talks. This isn’t good news for the pound, as it means that a cliff edge, otherwise known as hard Brexit, is still a possibility. A clean break like this could negatively impact the UK economy and, thus, the pound.. Although, on the other hand, it does give the quarreling UK Cabinet some time to organise their thoughts as they struggle to agree on what a transition deal should look like.

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.

Today is once again light on any highly relevant UK economic data that may influence the pound. Instead, investors will need to look towards Thursday for the speech by Bank of England Governor (BoE) Mark Carney and the release of UK consumer confidence data.

At the latest Bank of England monetary policy meeting, the central bank indicated they may consider tightening monetary policy over the coming months. In other words, an interest rate rise could be on the cards. The risk for Thursday’s speech is that if Mark Carney adopts a more conservative tone, then the pound could come under pressure as the market’s perceives lower odds of an interest rate hike.

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.

Macron appeals for deeper EU integration as euro continues to fall in German election aftermath

While German Chancellor Angela Merkel is scrambling to build a coalition party, the euro has continued to sell off. The EU, with the driving spirit of French President Emmanuel Macron and along with Angela Merkel, has been looking to implement several large reforms, such as the creation of a strong Eurozone Financial Minister. Despite Macron’s fresh appeal for a more powerful EU, any such reforms will now have dropped a fairly long way down the list of priorities for Angela Merkel, and this could weigh on the demand for the euro.

It’s also worth keeping in mind that since the French Presidential elections in May, which saw the populists defeated, the euro has been acting as some sort of a political haven. Even more so given the political risks with US (North Korea) and UK (Brexit). However, the return of the populist vote in Germany shows that political risk in the EU bloc is alive and well.

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