GBP/EUR: Euro Rallies vs. Pound As Italy Seeks To Avoid Debt Crisis

UK Construction PMI posting it weakest rise in six months sent the pound lower versus the euro on Tuesday. The pound euro exchange rate fell to a low of €1.1219 as concerns over a second dent crisis in Europe eased.

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.

UK Construction activity slowed to its weakest output in six months in September. Construction activity dipping to 52.1, down from t52.9 in August disappointed pound traders. Brexit uncertainty continues to be responsible for declining business confidence and investment. Political uncertainty is acting as a key drag on decision making with companies adopting a wait and see approach. As a result the construction sector has slowed down dramatically. The weaker than forecast figures sent the pound tumbling lower.

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.

Today sees the release of the service sector pmi. The service sector is by far the largest driver of the UK economy. If there is a slow down in the service sector this greatly increases the chances of a slowdown in the third quarter GDP reading. Analysts are expecting that activity in the service sector will have slowed slightly from August. This could send the pound lower. However, it is worth noting that the UK consumer has proven to be resilient over the past few months, so there is a possibility that the service sector pmi will show resilience as well. Should this be the case the pound could rally.

The UK Conservative annual party conference draws to a close today. Investors will be watching Prime Minister Theresa May for any Brexit developments.

Euro Relief Rally On Italy

The euro was broadly out of favour on Tuesday, albeit less so than the pound. Eurozone producer price index (PPI) data painted an encouraging picture for inflation which helped support the euro. PPI represents inflation at wholesale level. An increase of PPI usually indicates a pick up in consumer inflation down the line and higher inflation leads to a boost in interest rates.

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.

Despite the stronger data, euro investors were focused on Italy. Market participants had been starting to expect a full on collision between the Italian coalition populist government and Brussels over Italy’s spending plans. However reports overnight suggest that Italy is planning to reduce its budget deficit to 2% of GDP in 2020. This has boosted the euro as investors believe the European Commission are more likely to approve Italy’s spending plans if Rome shows intentions to lower the budget deficit going forward. A lower deficit would also help Italy avoid a debt crisis, a concern which had been weighing on demand for the euro over recent sessions.

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