The economic calendar on Wednesday was once again rather empty leaving investors to focus on the Bank of England interest rate decision today. The pound euro exchange rate continued to climb steadily higher , hitting a peak of €1.1458 in its third straight winning session.
|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 Bank of England will release its interest rate decision today, in addition to the quarterly inflation report and economic forecasts. Just one month ago the probability of a rate hike by the BoE was sitting at around 90%. However, after a month of souring UK economic data, the probability has sunk to just 10%.
UK inflation fell closer towards the central banks’ target and UK economic growth was a lacklustre 0.1% quarter on quarter, its weakest level since 2012. These numbers will almost certainly convince the BoE’s Monetary Policy Committee (MPC) that the economy is too weak to handle a rate hike immediately. As investors are not expecting the BoE to increase rates, it will be more a case of what the central bank says, rather than what is does that determines the direction of the pound. Therefore, investors will pay close attention to the accompanying statement, press conference and revised growth forecasts. Investors will want to see the central bank minimize recent bad data and keep the option of a rate hike later in the year firmly on the table.
Any signs of optimism from the central bank could kick the pound higher. On the other hand, a cautious sounding BoE, which considers weak data as the new norm, could drag sterling 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.
The euro was under pressure for the third straight session on Wednesday as investors brought into the dollar. The euro often trades inversely to the dollar. The dollar is currently in demand as investors bet on more interest rate hikes from the Fed and as concerns over the US pulling out of the nuclear deal with Iran has also supported the dollar.
The US pulling out of the international nuclear deal with Iran is yet another example of hard handed approach that the US is taking, turning its back on relations with the rest of the World and the EU. President Trump ignored pleas from EU leaders to remain in the deal and comes hot on the heels of the US steel and aluminium sanctions on the EU.
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.