GBP/EUR Could Drop Further Should Concerns Over UK Economy Persist

The pound managed to hold its ground against the euro for the majority of the previous week, despite lacklustre economic data. The pound-euro exchange rate hovered around the €1.1400 level for most of the week, before diving to €1.1291 on Friday.

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.

The pound had survived a hat-trick of weaker than expected business activity and confidence data from the manufacturing, construction and service sector in the first part of last week. Soft data on Friday was just too much for the pound to bear.

Manufacturing production for May was expected to grow 0.4% month on month and actually declined. Industrial production was forecast to expand both annually and monthly, yet declined. Construction activity was also forecast to increase by 1.1% and instead printed at -0.3%.

All the data coming in across the week highlighted the growing concerns over the resilience of the UK economy. Investors are increasingly more concerned over the outlook for Britain’s economy, especially given that things could get a lot worse before they improve. The soft data and weak outlook for Britain’s economy pulled the value of the pound lower on Friday.

Why does poor economic data drag on a country’s currency?
Slowing economic indicators point to a slowing economy. Weak economies have weaker currencies because institutions look to reduce investments in countries where growth prospects are low and then transfer money to countries with higher growth prospects. These institutions sell out of their investment and the local currency, thus increasing supply of the currency and pushing down the money’s worth. So, when a country or region has poor economic news, the value of the currency tends to fall.

The week ahead promises to be busy for the pound as far as economic data is concerned. Firstly, Monday sees the release of retail sales. The markets will be looking for further evidence as to whether households are still spending despite the squeeze on pay packets. Tuesday, the UK inflation report will give clues as to whether the Bank of England still sees high inflation as a passing phase to “look through”. And on Wednesday, the average earnings report could give an insight as to whether wages are showing signs of improving as the cost of living gets higher.

ECB driving the euro

Whilst pound traders have been focusing on the health of the UK economy, euro traders are watching the European Central Bank intently. The euro is highly sensitive to any signs of an interest rate hike or the winding down of the current bond-buying programme. This is particularly the case since the last ECB monetary policy meeting minutes raised expectations of a rate rise. When rate hike expectations increase so does the currency.

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.

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