GBP/EUR: Euro Rallies vs Pound On Policy Tightening Optimism

The pound was under pressure from Brexit developments, or the lack thereof. Meanwhile, the euro was in demand as optimism grew over the European Central Bank (ECB) bringing the quantitative easing programme to an end. The pound euro exchange rate dropped 0.3%, dipping below €1.14.

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.

While economic data earlier in the week had offered support to the pound, the quiet economic calendar on Wednesday meant investors’ attention was on Brexit. Businesses both in the UK and in the European Union are sending increasingly urgent warnings over the economic damage that Brexit could cause. However, the UK government remains deeply divided about the direction that it wants Britain to take.

Time is ticking with the UK due to leave the European Union in under a year. However, UK Prime Minister Theresa May has been slow coming forward with firm proposals over the future relationship between the UK and the EU. Theresa May refused to say when her team would be publishing a white paper setting out the UK’s negotiating position. Given that the government is so deeply divided between a hard or soft Brexit they are clearly struggling to put a plan together.

Why is a “soft” Brexit better for sterling than a “hard” Brexit?
A soft Brexit implies anything less than UK’s complete withdrawal from the EU. For example, it could mean the UK retains some form of membership to the European Union single market in exchange for some free movement of people, i.e. immigration. This is considered more positive than a “hard” Brexit, which is a full severance from the EU. The reason “soft” is considered more pound-friendly is because the economic impact would be lower. If there is less negative impact on the economy, foreign investors will continue to invest in the UK. As investment requires local currency, this increased demand for the pound then boosts its value.

With no high impact UK data due today, investors will continue to watch for Brexit headlines.

ECB QE Talk Boosts Euro

The euro was broadly in favour in the previous session as investors grew excited over reports that the ECB will look to discuss the end of the QE programme at the meeting this month. The QE programme has been the elephant in the room for much of the year. The ECB has consistently refused to discuss how they intend to end the QE programme, which was extended until September 2018.

Ending the QE programme is a form of tightening monetary policy. The ECB have always stated that interest rates will not be raised until after the QE programme has terminated. Therefore, by talking about the end of the programme the ECB is taking a step closer to raising rates. As a result, the euro moved higher

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 economic data is back in focus with German factory orders and eurozone GDP potentially causing volatility.

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