Pound versus Euro Driven by Political Developments in Catalonia & BoE Rate Decision This Week

The euro sold off sharply at the end of last week as political turmoil in Catalonia escalated. The pound euro exchange rate rallied on euro weakness, ending the week at €1.1328 for the pound. This is the highest level that the pound has traded at since early October and represents an increase of over 1.1% across last week.

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.

This week promises to be a busy one for the pound. The highlight is set to be the Bank of England (BoE) monetary policy decision on Thursday, where analysts widely believe that the central bank will hike interest rates for the first time in a decade. Investors are placing an 80% probability on the interest rate hike happening. Should the central bank opt to keep rates on hold, then the pound could fall lower.

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.

Before the BoE decision there are several economic data releases which could cause unrest among pound traders. If the data shows any signs of severe weakness in the UK economy between now and Thursday, this could also weigh heavily on the pound. This is because investors could fear that very weak data will reduce the odds of an interest rate hike by BoE on Thursday.

Tensions in Catalonia Drag Euro Lower

Political risk stemming from Catalonia in Spain took its toll on the euro on Friday, and could weigh on sentiment for the common currency at the start of the new week. News that the Catalan leader Carles Puidgemont announced independence was shortly followed by a vote in the Spanish Senate to ratify direct rule from Madrid over the region. Over the weekend, political unrest spilled over into the streets with an anti-independence march filling streets in Barcelona. Rep orts also said that Carles Puidgemont refused to accept his dismissal and intends to go to work in defiance of Madrid.

Previously, the impact of the independence vote had been particularly evident in the Spanish stock market. This suggests that investors were viewing the events as a predominantly domestic issue rather than a EU-wide issue. However, the euro’s decline on Friday suggests that investors are increasingly nervous as to how this drama will play out going forward. Therefore, as the political risk increased, the value of the euro decreased.

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.

Politics aside, there is plenty of economic data for euro traders to process today. First up, German retail sales data. Analysts are forecasting an impressive increase of 3.5% annually. Meanwhile, analysts are also anticipating economic sentiment across the eurozone to move higher. Strong readings from these data points could offer support to the euro.

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