The pound euro exchange rate experienced a turbulent session on Tuesday, although it finished the day more or less where it had started; at €1.1180 for sterling. The euro remained resilient versus the pound while Catalonia’s leader Carles Puigdemont signed and then suspended the declaration of independence.
|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.
Pound investors pushed concerns over Brexit and any domestic political fears to the back of their minds on Tuesday and instead chose to focus on positive economic data in the UK. UK manufacturing data beat analysts’ forecasts, increasing 1.8% year on year in August. Industrial production output grew by 2.8%, significantly higher than the 1.9% forecast by analysts. The sectors are finally showing signs of a revival after a sluggish start to the year.
The data has boosted investors expectations that the Bank of England will raise interest rates in November. As a result, the pound was back in demand versus the euro.
|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.|
However, any gains in the pound were capped as the International Monetary Fund (IMF) gave a grim picture of Britain’s economic outlook over the coming years. At the annual meeting between the World Bank and the IMF, the latter said that the negative effects of Brexit were starting to show in Britain’s economy. Therefore, the IMF cut Britain’s long economic growth forecast to 10.3% over the next five years, putting its growth rate behind Greece which is forecasted to grow at 11.5% over the same period. It also cut the UK’s growth forecast for this year to just 1.7%.
While pound traders tried to focus on the good news in the previous session, these figures from the IMF could keep pressure on sterling rate versus the euro.
The euro was showing few signs of stress as Catalonia’s separatist leader Carles Puigdemont told the Catalan Parliament that he has a mandate for independence, but won’t be implementing it for a few weeks. There had been concerns that he would declare unilateral independence from Spain immediately. Instead, Puigdemont signed and then suspended the declaration and called for negotiations with Spain, in an attempt to resolve the conflict.
The almost non-existent response of the euro show that investors are considering Catalonia’s independence as a minor risk which European leaders will need to step around. Investors have interpreted this as an internal affair rather than a Eurozone-wide issue.
That said, the situation has by no means been resolved. Although tensions have eased, political risk is still running high. Investors will keep an eye on negotiations over the coming weeks, any signs of political instability could weigh on the state of euro versus the pound.
|How does political stability boost a currency?|
|Political stability boosts both consumer and business confidence, which means corporations and regular households alike are more likely to spend money. The increased spending, in turn, then boosts the economy. Foreign investors prefer to invest their money in politically stable countries as well as those with strong economies. For foreign investors to put their money into an economy, they need local currency. As they acquire the money needed, the demand for that particular currency increases, which then boosts its value.|
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.