A surge in inflation followed by increased Brexit concerns sent the pound euro exchange rate on a rollercoaster ride on Wednesday. The pound soared to a high of €1.1284, before sharply dropping back to a low of €1.1212.
|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.
An unexpectedly sharp rise in inflation in August sent the pound spiking higher in the previous session. UK inflation jumped to 2.7% month on month thanks to an increase in airfares, clothes and computer games. Analysts had been expecting inflation to decline to 2.4% from 2.5% in July.
The jump in inflation supports the Bank of England’s decision to raise interest rates at the meeting in August, in an attempt to slow the rising prices that have been prevalent in the UK economy over the past 2 years. The pound jumped as higher inflation often encourages the central bank to consider hiking interest rates sooner rather than later.
|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.|
It is also worth noting that inflation figures can vary month to month and on the whole analysts still believe that the trend for inflation is downwards towards the BoE’s 2% target.
Brexit was the other big driver for the pound on Wednesday. Sterling quickly gave back its gains after Theresa May rejected the EU’S improved offer from EU Chief Negotiator Michel Barnier over the Irish border issue. A rejection would mean that the issue remains unresolved with the clock still ticking towards the Brexit deadline. Without a solution to the Irish border issue a Brexit deal looks unlikely.
|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.|
The outlook for the euro hasn’t altered much this week. There has been little in the way of economic data for the region. With little else to go on, the euro has been trading at the mercy of the dollar. The euro often trades inversely to the dollar. As the dollar slipped on reduced trade war tensions, the euro has gained ground.
Today euro traders will look towards consumer confidence data. Analysts are expecting confidence in the region to have dipped slightly to -2 in August, down from -1.9 in July. Whilst this is an improvement from earlier in the summer, it is still significantly below the average. A strong reading could boost the euro
This publication is provided for general information purposes only and is not intended to cover every aspect of the topics with which it deals. It is not intended to amount to advice on which you should rely. You must obtain professional or specialist advice before taking, or refraining from, any action on the basis of the content in this publication. The information in this publication does not constitute legal, tax or other professional advice from TransferWise Inc., Currency Live or its affiliates. Prior results do not guarantee a similar outcome. We make no representations, warranties or guarantees, whether express or implied, that the content in the publication is accurate, complete or up to date. Consult our risk warning page for more details.
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.