GBP/EUR: Will UK Service Sector PMI Lift Pound vs Euro?

The pound euro exchange rate tumbled on early trade on Wednesday, before regaining lost ground towards the end of the session. The exchange rate hit a low of €1.1420 before rising back towards break even at €1.1463 by the end of the day.

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.

Data showing that U.K. construction sector activity unexpectedly contracted in March weighed on sentiment for the pound. Analysts had been anticipating that construction activity to have expanded in March, albeit at a slightly lesser rate than in February. Instead of the 51 analysts had forecast, the construction pmi printed at just 47, with 50 separating expansion from contraction. This shows that U.K. construction activity seized up, with recent bad weather in the U.K. hitting the industry hard as snow related disruption was a key factor behind the unexpected contraction in the sector. Whilst the U.K. economy isn’t heavily dependent on the construction industry, the weaker than forecast figure sent 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.

U.K. economic data will remain in focus today as investors centre their attention on service sector activity. Once again analysts are expecting a slowdown in growth for the UK service sector. This could spell further negativity for the pound, given how important the service sector is to the UK economy’s economy.

Eurozone unemployment lowest since 2008

Euro traders cheered some encouraging data from the eurozone. Eurozone inflation finally showed signs of life in March, ticking higher to 1.4%, in line with analysts’ expectations. Meanwhile unemployment in the bloc also fell to its lowest level in 10 years. This will be some welcomed good news for European Central Bank policy makers who have been waiting for inflation to move high and the labour market to start tightening for some time.

However, core inflation, which strips out more volatile items such as food and fuel missed analysts expectations, increasing just 1%, instead of the 1.1% forecast. The lower core inflation level is likely to encourage the ECB to remain patient over raising rates. The initial reaction was a rally in the euro, as traders hoped interest rates could be raised sooner. However, the after thought focused on core inflation which remains disappointingly low making any rate rise still a long way off.

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.

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