Will UK GDP & Brexit Woes Pull The Pound Lower vs. Euro?

The pound was under pressure on Thursday amid little progress on Brexit and a cautious tone from the Bank of England (BoE). The pound euro exchange rate dropped 0.4% across the day reaching a low of €1.1275. This is the weakest that the pound has traded at versus the euro in over 3 months.

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.

As the EU Summit began, Irish leader Leo Varadkar said that the lack of progress on Brexit was “disappointing”. The deadline for the Irish border issue was this Summit, but it is clear that a new deadline will need to be set because the two sides are nowhere near a solution. The Irish leader also suggested that a no deal Brexit was looking there increasingly likely.

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.

Adding to the pound’s woes, BoE policymaker Jon Cunliffe expressed concern for the level of household debt in the UK. Should interest rates be raised whilst there are high levels of debt, the economy could move back into recession, said Jon Cunliffe. Market participants have interpreted these comments as dovish; Jon Cunliffe is unlikely to vote for an interest rate rise if he believes it could start a recession. The pound dropped on his comments.

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 UK GDP data will be a central focus. Analysts are anticipating that the British economy will have grown by a rather lacklustre 1.2% as Brexit uncertainties continue to impact on the economy. A strong reading that predicted could help lift the pound from its 7-month lows.

Eurozone Inflation to Decline?

The euro experienced a more upbeat session on Thursday as market participants focused on solid eurozone confidence figures, rather than falling inflation in Germany. The rate of inflation as measured by the consumer price index (CPI) fell in June to 2.1% from 2.2% in May. Whilst this is still above the European Central Bank’s 2%, most of the increase over the past few months has come from a rally in oil.

Investors will now look ahead to the eurozone CPI figures and perhaps more importantly the eurozone core CPI numbers which don’t include more volatile items such as food and fuel. A decline in these figures could see the euro fall lower as lower inflation means any increase in interest rates less likely.

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