Despite moving higher after some encouraging data from the UK construction sector, the pound has fallen steadily against the euro across the week. After falling 0.3% versus the common currency in the previous week, the pound was down a further 0.25% so far this week. In Thursday it hit a low of €1.1326 as it remains at levels not seen for 6 weeks.
|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.
One again the lack of enthusiasm for the pound came from economic data which was weaker than analysts had been anticipating. After a soft reading for manufacturing activity but a solid rebound in construction activity, investors and analysts alike were optimistic that a rebound in the service sector was also on the cards. Analysts forecast that the UK service sector activity expanded to 53.5 in April after falling to 51.7 in March. Whilst the sector did rebound, it only did so to a reading of 52.8 and therefore fell short of expectations. Given that the service sector is the dominant sector in the UK economy, the disappointment impacted 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.
Data across April has been considerably weaker than what analysts had been forecasting, pointing to a struggling British economy. Just a month ago market participants were almost certain that the Bank of England was going to hike interest rates. This is now looking highly improbable. The central bank will give its rate decision next week following the Monetary policy Committee (MPC). This will be the main focus for trading next week.
The euro managed to rise against the pound despite eurozone inflation failing to live up to analysts’ forecasts. Inflation as measured by the Consumer Price Index (CPI) remains sluggish, dropping to 1.2% year on year in April. Core inflation, which removes more volatile items such as food and fuel slipped to just 0.7%, down from 1% in the previous month and still a considerable distance from the European Central Bank’s target of 2%. Whilst ECB policy maker are confident that inflation for the bloc will eventually hit the target, this could still be some years away. A central bank will look to raise interest rates once inflation is close to the central bank’s target, which means any hike could still be some 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.
This week has been a busy week for eurozone data and it finishes with retail sales for the bloc. A weak number for retail sales could see the euro give up today’s gains versus the pound.
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.