GBP/EUR: UK & Eurozone Inflation to Drive Pound vs. Euro

Impressive UK jobs data sent the pound soaring higher versus the euro on Tuesday. The pound euro exchange rate rallied from a low of €1.1350 to a high of €1.1424. This is the highest level that the pound has trade versus the euro in 3 sessions.

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.

Whilst analysts were expecting Brexit headlines to drive the pound on Tuesday, investors found it hard to ignore the eye-catching jobs data released. Data showed that UK wages grew at the fastest pace since 2009. Average earnings, excluding bonuses rose 3.1% in the three months to August. Unemployment remained constant at a multi decade low of 4%.

These figures show that some bright spots remain in the UK economy. The faster earnings growth could encourage the Bank of England to raise interest rates sooner, to prevent inflation from rising too high. As higher interest rates make holding sterling more profitable, investors brought into the pound pushing it higher.

However, the gains were limited because of the uncertainty that Brexit is causing. The BoE’s next steps are very dependent on whether the UK has an orderly or disorderly 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.

Today sees the release of UK inflation data. Analysts are expecting the consumer price index (CPI) to have ticked down marginally in September from August’s 2.7% reading. An easing of inflation could see the pound give up the gains from the previous session.

Slumping German Economic Sentiment Sends Euro Lower

A sharp drop in economic sentiment in Germany and the eurozone sent the euro lower in the previous session. The ZEW German economic sentiment index measures finance professionals view of the German economy. It is closely watched because a weakening sentiment index is historically followed by an economic slowdown.

Finance professional’s opinion on the German economy has darkened considerably. The sentiment index plunged to -24 in October from -10.7 in September. This was significantly short of analysts expectations of -12. The increasingly gloomy picture comes as Germany faces domestic political instability, in addition to trade tensions with US and Brexit related uncertainty.

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.

The euro could be in recovery mode tomorrow as investors look towards eurozone inflation data. Analysts are expecting inflation in the region to tick higher to 2.1% year on year in September, up from 2% in August. Higher inflation increases the probability of the European Central Bank hiking rates sooner.

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