Pound Moves Higher vs. Euro As Central Bank Heavy Week Begins

The pound finished the previous week 0.2% higher versus the euro, after the UK finally managed to secure a deal on Brexit divorce bill with the EU. The divorce bill is an amount that the bloc wants UK to pay to cover for financial losses that Brexit will cause. The pound hit a 6-month high of €1.1510, before closing the week softer at €1.1383 versus the euro. The exchange rate heads higher as the new week begins.

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.

On Friday, at the 11th hour before a deadline set by the EU, the UK reached an agreement over the Irish border allowing Brexit talks to move forward. The Irish border dispute had resulted in Brexit talks breaking down a week ago. However, now that an agreement between all parties involved has been reached upon, it means that UK has been judged to have made sufficient progress to move to 2nd second stage in negotiations with EU. This second stage will involve talks covering broader issues such as the EU-UK post Brexit relationship and a possible transitional deal. This increases the possibility of a smooth Brexit, which is pound beneficial. However, fears that there is not enough time to put together a trade deal before March 2019, weighed on sentiment towards the pound heading into the weekend.

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.

Central bank action will be a big focus this week for both the UK and the eurozone. The Bank of England (BoE) is due to give its monetary policy decision on a Thursday. Economists are expecting the central bank to keep interest rates on hold. Investors will be paying close attention to comments made by BoE Governor Mark Carney and his associates at the Bank. Should they continue to show unease over the current high levels of inflation, investors could start to look towards another interest rate rise in 2018, which would boost the value of sterling.

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.

Also catching the attention of investors this week, will be the UK inflation numbers on Tuesday and employment and average wages on Wednesday.

No Change Expected from the ECB

Developments in the political situation in Germany helped boosted the euro on Friday. Since the German elections over 2 months ago, Angela Merkel and her party, the Christian Democratic Union (CDU) have been unable to form a coalition government. At the end of last week, Martin Schulze, the leader of the German Social Democrats (SPD) agreed to begin preliminary coalition talks with the CDU. After months of deadlock, investors are relieved to see some progress at last, which boosted the euro.

Market participants are not expecting any change in monetary policy direction from European Central Bank when they meet on Thursday. However, economists are expected to raise growth forecasts for the bloc, which could be euro-positive.

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