The pound lost ground versus the euro across the previous week. Whilst Brexit fears pulled the pound lower, a calmer political scene in Italy and optimism over a more aggressive European Central Bank (ECB) helped lift the euro. At the start of the new week, the euro was still showing signs of strength pulling the pound euro exchange rate lower at €1.1390.
|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.
Last week was a reasonably quiet week for the UK economic calendar, with just the purchasing managers indices catching investors’ attention at the start of the week. As a result, market participants focused on Brexit issues for much of the second part of last week.
UK Prime Minister Theresa May gave in to hard-line Brexit supporters in her government saying that the UK would not stay in the EU single market and customs union past 2021. Even in the case of there being no solution to the Irish border problem. This was then rejected by the EU, leaving the position of the UK once again very uncertain. Increased levels of uncertainty are squashing hopes of a softer Brexit, which is bad news for the pound.
|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.
This week there is plenty of economic data to grab investors’ attention. Today sees manufacturing and industrial production data, in addition to NIESR economic growth data. Whilst analysts are expecting manufacturing to have picked up from last month, industrial production is forecast to have fallen. Meanwhile, analysts are predicting that the NIESR GDP reading will tick up from 0.1% to 0.3%. This could help boost the pound.
The euro was in demand last week after strong hints by senior bank policymakers that the ECB will discuss an end date for the quantitative easing programme when it meets this week. Should the ECB look to end the bond buying programme in December, as analysts are anticipating, it would then pave the way for interest rate hiking in 2019. The euro gained last week on these expectations and has started on the front foot this week for the same reason.
|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.
However, should the ECB surprise market participants by winding down the programme over a longer period of time, the disappointment could pull the euro sharply lower.
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.