A very quiet UK economic calendar in the previous session meant pound traders lacked any fresh reasons to buy into the currency, so movement in the pound euro exchange rate was mainly due to euro movements. Unencouraging remarks from European Central Bank officials, in addition to a weaker inflation reading meant the euro was out of favour on Wednesday. As a result the pound euro exchange rate gained ground, hitting a high of €1.1351.
|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.
Following weaker UK inflation figures earlier in the week, the pound was struggling to make any meaningful move higher. With inflation slipping back towards the Bank of England’s 2% target, the prospects of an interest rate hike have also diminished.
|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.|
Instead investors will now be looking ahead to retail sales data due on Friday for a clearer picture over the health of the UK economy. Concerns are running high that consumers may rein in their spending due to high inflation and lower average wage increases putting pressure on household pay checks. So far the UK consumer has been relatively resilient, continuing to drive the UK economy post Brexit. Signs of a slowdown could concern investors and pull the pound lower
|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.|
The mood for the euro dipped on Wednesday after several stronger sessions. Data showed that inflation for the bloc came in at 1.4% in December, a dip from 1.5% in November. The reading was as city analysts had expected, however it still remains a long way from the European Bank’s 2% target rate. The fact that inflation is refusing to pick up in the eurozone, despite a solid economic recovery is unnerving investors. Without stronger inflation the European Central Bank (ECB) will not consider raising interest rates. While ECB President Mario Draghi remains optimistic that inflation will eventually move higher, investors didn’t share his optimism and sold out of the common currency.
The eurozone economic calendar is quiet today leaving investors time to focus on the recent comments from ECB officials ahead of the ECB monetary policy next week. So far ECB officials have given off conflicting messages over the next steps of the central bank. Today Weidmann and Coeure are due to speak in Frankfurt. Investors will listen closely for any clues as to the expected timing of any policy tightening.
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.