Better than expected inflation figures helped lift the pound against the euro on Tuesday. The pound euro exchange rate climbed to a high of €1.1374 for the pound, after several downbeat sessions.
|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.
Inflation in the UK climbed to a six year high of 3.1% in November, beating city analysts’ expectations that it would remain steady at 3% year on year. On a monthly basis, inflation jumped to 0.3%, ahead of October’s 0.1% and ahead of analysts forecasts. The strong increase in the cost of living in the UK is pushing investors to believe that the Bank of England (BoE) may raise interest rates more aggressively next year, in order to bring inflation back closer to the central bank’s 2% target. This boosted the pound.
|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.
The reality is that the BoE is unlikely to act any time soon. The general consensus at the central bank is that the high inflation, as a result of the weaker pound post Brexit referendum, will start to return to more acceptable levels by the end of the 1st quarter next year.
Today investors will be looking at UK wage data. Analysts are anticipating that average wages increased 2.5% in the three months to October. This would represent a 0.3% increase from the three months to September and would mean that the squeeze on household purses, while still substantial, would be declining. Should this be the case the pound could move higher.
|How does strong jobs data boost the currency?
|It works like this, when there is low unemployment and high job creation, the demand for workers increases. As demand for workers goes up, wages for those workers also go up. Which means the workers are now taking home more money to spend on cars, houses or in the shops. As a result, demand for goods and services also increase, pushing the prices of the good and services higher. That’s also known as inflation. When inflation moves higher, central banks are more likely to raise interest rates, which then pushes the worth of the currency higher.
The euro was out of favour in the previous session, falling against most of its major peers. German economic sentiment unexpectedly weakened in December, reflecting the political uncertainty in the country. Germany is yet to form a government despite elections taking place over 2 months ago. Concerns over Brexit were also cited as reasons for doubt over the future.
That said the reading of the ZEW confidence report was still high, and positive, and this indicates that the majority of investors still see economic conditions improving in the next six months.
Today eurozone employment and industrial production figures will be in the spotlight. Signs that the eurozone economy remains healthy and robust, could see the euro regain lost ground.
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.