GBP/EUR: Pound Steady vs Euro Despite Stark IMF Brexit Warning

The pound euro exchange rate traded within a tight range on Monday.. With both the euro and the pound broadly in favour, the pair traded most of the day flat before the pound advanced towards the close, finishing atf €1.1266.

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.

Pound traders were largely ignoring warnings by the IMF that a no deal Brexit would hit the UK economy. Christine Lagarde, head of the IMF stated on Monday that a disorderly exit from the EU would have dire consequences, with risk of a recession running high. The IMF currently predict that the UK economy will grow at 1.5% next year, based on a smooth exit from the EU. In the case of a hard, no deal, disorderly Brexit the IMF foresee the UK economy contracting rapidly. This view from the IMF supports the general view of economists that a soft Brexit will be better for the UK economy than a hard Brexit.

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.

Chancellor Philip Hammond was quick to endorse the IMF’s findings, challenging Prime Minister Theresa May’s position that the UK will succeed under any Brexit scenario. Theresa May’s stance comes as she attempts to convince Brussels that she is prepared to walk away from the negotiating table, if needs be.

Today, once again there is no high impacting economic data. As a result, pound investors will continue to focus on Brexit developments.

Euro Inflation Remains At 2%

Euro investors cheered eurozone data in the previous session. Consumer price index (CPI) figures for the region showed that inflation remained constant at 2%. This remains in line with the European Central Bank’s target and makes the winding down of the bond buying programme at the end of the year, increasingly likely.

Analysts consider the winding down of the bond buying programme as hawkish and a step closer to rising interest rates. So, although analysts are not expecting an interest rate rise until the summer of 2019, inflation at 2% and the conclusion of the bond buying programme are steps on the way to tighter monetary policy.

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 be looking towards ECB Governor Mario Draghi, who is due to make a speech.

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