The pound dived versus the euro on Thursday despite the Bank of England hiking interest rates. The pound hit a low of €1.1204 before clawing back some lost ground towards the close.
|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 BoE voted unanimously to raise interest rates by 0.25% to 0.75%. This is the highest level for interest rates in a decade. The central bank voted 9-0 in favour of a hike, which lifted the pound higher. However, the rally was short lived as cautious comments from BoE Governor Mark Carney sent the pound tanking lower.
Going into the meeting, investors had been getting their hopes up that there could be another rate hike before the year was over. Mark Carney warned against the markets getting ahead of themselves, citing short terms factors from holding the central bank back from more interest rate increases. In short, Mark Carney indicated that there would not be another rate rise this year due to Brexit. As hopes of a second hike were dashed, the pound fell 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.
Today, investors will remain focused on the economic calendar, with service sector activity in focus. Analysts are expecting the service sector purchasing managers index to show that activity slowed in July to 54.7 from 55.1 in June. Given that the service sector is responsible for around 80% of economic activity in the UK, even a slight slowdown in the sector can have an impact on UK economic growth.
|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.
Demand for the euro was also soft on Thursday, albeit less so than the demand for the pound. The euro was trading lower, principally because of the strong rally in the dollar. The euro often trades inversely to the dollar.
The dollar has charged higher as trade war tensions are building up once again. Earlier in the week President Trump threatened to increase tariffs from 10% to 25% on US$200 billion worth of Chinese imports. China promising a retaliation heightened fears that this is actually just the beginning of the trade war. The dollar has safe haven appeal, so in times of geopolitical stress, investors often look to buy the dollar. As a result, the euro weakened.
Today investors will cast an eye towards eurozone retail sales data, which analysts are expecting to remain constant in June at 1.4% year on year.
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