GBP/EUR: Will Eurozone Inflation Lower Euro vs Pound?

The pound euro exchange rate traded within a tight range on Thursday, on a quiet day of trading for both currencies. After dipping marginally in early trade, the pound regained strength, finally pushing higher versus the euro. The pound ended the day at €1.1336.

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.

The pound initially lost ground in the previous session as investors grew increasingly nervous over the escalating tension between UK and Russia. Following the poisoning of Skirpal, an ex-double agent, all fingers pointed to Russia. UK Prime Minister Theresa May has since called for sanctions against Russia and expelled 23 Russian diplomats from the UK, Russia are now expected to retaliate. Britain has received support from the allis and the US. Geopolitical tensions are at the worst level since the Cold War between Russia and Britain, which unnerved buyers of the pound.

Brexit news then gave the pound a boost, picking it up off session lows. Reports suggest that the Brexit transition deal is imminent as Brexit Minister David Davis id due to travel to Brussels this weekend. Unlike last year when David Davis was regularly seen in Brussels, this year he has avoided going. So the fact that he is on his way, is most likely because he thinks a deal is imminent. This boosted the pound, because a transition deal would help UK businesses and therefore the UK economy adjust to Brexit. This is beneficial for the pound.

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.

Today’s UK economic calendar is once again empty. Market participants will be watching carefully for any headlines pointing to a transition deal being completed over the weekend or any worsening of relations between UK and Russia.

Eurozone Inflation in focus

The euro drifted lower in the previous session as investors continued to digest a cautious sounding European Central Bank. With no fresh news or data to go on, the euro continued to weigh up the prospect of low inflation in the eurozone, pushing back the potential of any rate hike from the ECB.

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.

Today investors will receive an update to those inflation figures, with the release of eurozone consumer price index (CPI). Analysts are forecasting that inflation will drop on a year on year basis from 1.3% in January to 1.2% in February. Core inflation is expected to stay constant at just 1%. After Draghi warned on sluggish inflation, a weaker than forecast reading could send the euro lower.

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