GBP/EUR: Will Political Developments In Italy Lower Euro vs Pound?

The euro initially jumped versus the pound as the markets opened. However, the common currency quickly reversed as investors digested the results of the Italian elections. The pound euro was trading marginally moving into Monday at €1.1197.

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 = 1.28934 USD

Here, £1 is equivalent to approximately $1.29. This specifically measures the pound’s worth against the dollar. If the US dollar amount increases in this pairing, it’s positive for the pound.

Or, if you were looking at it the other way around: 1 USD = 0.77786 GBP

In this example, $1 is equivalent to approximately £0.78. This measures the US dollar’s worth versus the British pound. If the sterling number gets larger, it’s good news for the dollar.

The pound lost ground across the previous week as Brexit concerns dominated investors attention. Fears that the U.K. and the EU will not reach an agreement over the post Brexit transition deal dominated trading towards the end of last week. The distance between the two sides still appears to be two wide for negotiators to overcome within the few weeks left to discuss the matter. No transition deal would potentially leave the U.K. heading for a hard Brexit, the least pound friendly option.

Why is a “soft” Brexit better for sterling than a “hard” Brexit?
A soft Brexit implies anything less than UK’s complete withdrawal from the EU. For example, it could mean the UK retains some form of membership to the European Union single market in exchange for some free movement of people, i.e. immigration. This is considered more positive than a “hard” Brexit, which is a full severance from the EU. The reason “soft” is considered more pound-friendly is because the economic impact would be lower. If there is less negative impact on the economy, foreign investors will continue to invest in the UK. As investment requires local currency, this increased demand for the pound then boosts its value.

The end of last week U.K. Prime Minister Theresa May, also gave a much anticipated, key speech on her vision of the post Brexit U.K. EU relationship. However, the speech lacked substance and failed to provide anything new or concrete for investors to digest. Instead it confirmed fears that the UK is still unsure of where it is heading.

Brexit will remain in focus this week, with investors particularly keen to evidence of progress in Brexit talks.

Political gridlock in Italy

The euro wobbled as it opened for trading on Sunday evening, as investors considered the exit polls from the Italian elections. The centre right bloc has won the largest amount of votes, with polls pointing to 33%-36%. However, this remains below the 40% required for a majority. The anti establishment 5 Star movement are expected to have won 29% -32% making them the largest single party. Meanwhile, the current ruling centre left coalition looks set to come in third place as voters express their discontent for mass immigration.

It has not come as a huge surprise that the exit polls are pointing to a hung parliament, Italian politics are renowned for being messy and Sunday’s election was no different. However, there is a small element of concern that the anti establishment 5 Star movement could join forces with the Eurosceptic extreme right Lega Nord, to form a potentially dangerous coalition for the euro project. The political risk is weighing on demand for the euro.

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.

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