The pound dropped again versus the euro on Wednesday as the investors dealt with the UK labour market data. Sterling fell from a day’s high of €1.1223 to a low of €1.1178 for the pound, before picking up again into the close of the trading session.
|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.
UK labour market data showed that wage growth in the UK increased at 2.2%. This was in line with analysts’ forecasts and a slight improvement from last month’s 2.1%. However, it wasn’t sufficiently strong to give confidence to investors that the Bank of England (BoE) will raise rates in November. Strong wage growth usually tends to mean that inflation will increase further. Inflation is currently at 3% and the gap between wages and inflation remains fierce, which means that the purchasing capacity of UK households is being increasingly squeezed. A rate hike under such circumstance could prevent consumer from spending which could slow the economy drastically, possibly into recession. The BoE rate rise decision would therefore be extremely important.
|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, the focus will switch back towards Brexit headlines. An EU leaders summit will be held, at which a decision will be taken as to whether the UK can move forward in the Brexit negotiations. The next phase would enable the UK to discuss EU-UK trade deals and a transition period. Despite plenty of political lobbying from UK Prime Minister Theresa May, reports suggest that the EU leaders aren’t prepared to settle for €20 billion divorce bill, which could mean a smooth Brexit is off the table.
However, on a positive note, Theresa May has said that a deal on EU Citizens Rights is close. Such a deal would introduce a simple process by which EU nationals living in the UK could get a “settled status”. This was another key point that the EU wanted progress on before a transition deal can be discussed. As a result, the pound picked up moving into Thursday as the possibility of a smooth Brexit returned.
|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.|
The euro was in demand on Wednesday, ahead of a key Spanish deadline today. Following the Independence vote in Catalonia a week and a half ago, political tensions have been intense. Madrid gave Catalan leader Carles Puigdemonte until today to clarify if he is declaring independence or not. Should he fail to declare independence, Article 155 of the Spanish constitution could be applied, which would mean that Catalonia loses its regional powers. In this case, political risk would be running very high in Spain which could send the euro tumbling lower versus the pound.
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.