GBP/EUR: Will High Credit Levels Continue to Concern the BoE?

On a generally quiet day for both the pound and the euro, sterling steadily lost ground versus the common currency. Heading into Thursday, the pound was trading at €1.1150 versus the euro, having lost over 1.5% since the beginning of the month.

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.

After several quiet days on the economic calendar, pound traders are looking forward to a slightly busier schedule today. First, in the early hours the Royal Institution of Chartered Surveyors (RICS) house price balance will be announced. This number is based on opinions about housing price trends of a sample size of surveyors living in the UK. This is important because house prices usually rise in a strong healthy economy because people have stable, well-paid jobs and are able to comfortably take on credit. Therefore, demand for houses increase, pushing prices higher. However, last month saw house prices in London at their weakest since 2008. Poorer figures this morning could weigh on the pound versus the euro as it signals a weakening economy.

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.

Secondly, investors will look towards the Bank of England (BoE) third quarter Credit report. The central bank has previously expressed concerns over the level of consumer credit. Given that prices are rising and wages are failing to keep pace, consumers appear to be turning to unsecured credit in an attempt to bridge the growing gap. As interest rates are low, borrowing money has become cheaper; so, should the report show high rates of credit, it could actually encourage the BoE to raise interest rates in an attempt to discourage consumers from taking on credit. This would boost the pound rate versus the euro.

Will ECB Draghi gives clues to tapering the bond-buying programme?

The mood for the euro improved as the crisis in Spain continued to show signs of easing. Catalonia’s leader Carles Puigdemonte has backed away from declaring independence in favour of talks with Madrid, a move that has been cheered by euro investors. That said, a quick resolution of the issue in Spain is looking increasingly unlikely, so any developments in this situation could create volatility for the common currency.

How does political risk have impact on a currency?
Political risk drags on the confidence of consumers and businesses alike, which means both corporations and regular households are then less inclined to spend money. The drop in spending, in turn, slows the economy. Foreign investors prefer to invest their money in politically stable countries as well as those with strong economies. Signs that a country is politically or economically less stable will result in foreign investors pulling their money out of the country. This means selling out of the local currency, which then increases its supply and, in turn, devalues the money.

With political risk receding for the time being, investors are turning their attention to European Central Bank (ECB) President Mario Draghi, who is due to speak this evening, along with several other key members of the ECB policy making committee. Investors will be looking out for any hints on the winding down of the ECB’s bond-buying programme ahead of the October meeting. Should Draghi give any suggestion that the programme could stay in place for longer, the euro could find itself under renewed pressure.

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