GBP/EUR: Pound Vulnerable vs. Euro Amid Brexit & Political Chaos

The political crisis engulfing UK Prime Minister Theresa May over her Brexit deal sent the pound over 1.8% lower versus the euro in the previous week. The pound tumbled to a low of €1.1230 versus the common currency. This is its lowest level that the pair has traded at since last September.

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.h 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.

Brexit was the key driver of the pound last week, prompting levels of volatility in the pound not seen since the Brexit referendum. The resignation of Brexit Secretary Dominic Raab and other ministers as well as growing speculation that Theresa May could face a vote of no confidence sent the pound tumbling.

How does political risk have impact on a currency?
Political risk drags on the confidence of consumers and businesses alike, which means both corporations and regular households are then less inclined to spend money. The drop in spending, in turn, slows the economy. Foreign investors prefer to invest their money in politically stable countries as well as those with strong economies. Signs that a country is politically or economically less stable will result in foreign investors pulling their money out of the country. This means selling out of the local currency, which then increases its supply and, in turn, devalues the money.

The main focus will remain squarely on Westminster as the new week begins and on whether Theresa May can keep hold of power. Political analysts suggest that May could face a vote of no confidence as soon as Tuesday. According to reports seven UK Conservative lawmakers are preparing campaigns to oust the PM. Yet even if Theresa May does survive a vote of no confidence, she will still face the enormous task of pushing her Brexit deal through Parliament. As things currently stand, this is a challenge which political analysts consider to be mathematically impossible.

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.

With such elevated Brexit and domestic political risks, analysts expect volatility in the pound to remain elevated. Some analysts are predicting a 10% price swing between best and worst case scenarios.

Italian Woes To Weigh On Euro?

The euro has shown strength over the past week despite the brewing trouble between Italy and the EU. Italy is on course to receive fines from the European Commission over it’s Budget for 2019, after defying requests by Brussels to revise its spending plans. Italy’s expansionary Budget was rejected for defying spending rules. Rome has until Wednesday before the EC could apply unprecedented fines. However, the EC are aware that the populist Italian government will be looking to use any criticism for domestic political gain.

Today there is no high impacting economic data due for release. Later in the week, investors will look towards the minutes from the ECB meeting for further clues as to the direction of monetary policy.

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