After treading water for much of the day, the pound dropped sharply lower versus the euro after cautious comments from Bank of England governor Mark Carney. The pound tumbled around 100 points to €1.1410.
|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 stayed buoyant in early trade, even after retail sales in the UK fell by more than what analysts had been expecting in March. Retail sales volumes dropped -1.2% month on month, well short of the -0.6% decline expected. Meanwhile on an annual basis, retail sales grew a lacklustre 1.1%, below the 1.4% anticipated. This is the third set of disappointing data that investors have endured for the pound this week, after wage figures and inflation also fell short of forecasts earlier in the week.
Some market participants had hoped that the fact that wage growth outpaced inflation could the less squeezed consumer hit the shops and spend. However, harsh weather conditions and unseasonably late snow meant that shoppers remained inside staying away from the high street. As a result, retail sales fell, initially weighing on the pound.
|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.
Given the three sets of disappointing data prints from high impacting data this week, BoE governor said that markets were wrong to consider that a rate rise in May was a foregone conclusion. His words knocked investor confidence and the odds of a Spring rate rise, which had been as high as 90%, fell, pulling the pound lower.
|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.
With no fresh data the euro was broadly out of favour in the previous session. Investors continued to digest weak inflation figures from earlier in the week. Soft eurozone inflation reduces the possibility of the European Central Bank (ECB) raising interest rates anytime soon. Lacklustre inflation was a problem during the last year, even when economic growth was strong. This year, with economic growth momentum slowing, inflation could become softer still before improving.
Today the focus will stay will economic data. Inflation at factory gate level, in the form of producer price index and consumer confidence both have the potential to create volatility for the euro.
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.