The pound’s decline versus the euro seems to have been unstoppable over recent sessions. On Tuesday, the pound fell over 0.4% against the common currency. Which takes losses over the last 7 days to almost 1.5% for sterling. The pound finished the session at €1.1272, its weakest level in 10 days.
|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 was hit once again by poor UK economic data. Monday saw UK manufacturing activity disappoint and Tuesday it was the UK construction sector’s turn. In September, construction activity in Britain unexpectedly shriveled for the first time in over a year, as Brexit continues to weigh on the economy. Uncertainty over the future has dented confidence and meant companies have held off on new commercial building contracts. Despite poorer than expected construction numbers, UK housebuilding was at least a bright spot in the numbers, as new home construction appears to be holding up. However, there was a slight slowing in momentum there as well, highlighting how fragile the sector is. The disappointing numbers meant that the selloff in sterling continued.
|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.|
Today investors will be looking closely at the UK service sector numbers. The service sector is the most dominant area of the UK economy, contributing over 70% to Britain’s economic output. So, today’s service sector figures will give a good idea as to the health of the UK economy. If the manufacturing sector and construction sector readings are anything to go by, then a decline in service sector activity could be on the cards. A figure lower than the 53.2 forecasted by analysts could result in the pound dropping further. Any figure above 50 indicates expansion.
The euro experienced a revival of demand on Tuesday. Attention slowly shifted away from the independence vote in Catalonia and back towards the eurozone’s economic data. Tuesday’s producer price index (ppi) was the main source of support for the common currency. PPI is a measurement of inflation at factory level. Analysts predicted a 0.1% lift from July, but instead the EU’s August’s figure unexpectedly rose 0.3%.
This means that prices are on the rise in the eurozone and so inflation should also pick up. Higher inflation means the European Central Bank (ECB) is more likely to tighten monetary policy, for example by raising interest rates. As the odds of an interest rate increases so generally does the value of 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.|
Today euro traders will turn their attention to ECB President Mario Draghi. They will be paying particular attention to see if he can provide any further clues as to the possibility of an interest rate hike in light of the strong economic data.
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.