GBP/EUR: Will UK Inflation Data Pull Pound Lower vs. Euro?

After big swings in early trade on Tuesday, movement in the pound euro exchange rate calmed significantly later in the session. The pound euro pair ended Tuesday at €1.1125, approximately the same level that it had started at. The pound was edging modestly lower this morning.

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.

The pound had a spring in its step-in early trade on Tuesday, despite the start of no deal Brexit planning. With the probability of Brexit being voted through Parliament still looking slim at best, the government has ramped up preparations for a no deal Brexit. Normally thoughts of a no deal Brexit would send the pound tumbling lower. However, rumours of a second referendum are refusing to die down, which is offering support to sterling. Any hope that the UK might either not go through Brexit or have a softer version of Brexit lifts the pound. Leading economists have frequently stated that a no deal hard Brexit would be the most damaging to the UK economy and therefore the pound.

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.

In the absence of any further Brexit developments, investors will turn their attention to UK inflation data. Inflation as measured by the consumer price index (CPI) is expected to tick lower in November to 2.3%, down from 2.4%. Meanwhile core inflation, which removes move volatile items such as food and fuel, is forecast to dip to 1.8% down from 1.9% Whilst falling inflation is good news for the squeezed consumer, the BoE will be in no rush to hike interest rates when inflation is falling. This could drag the pound lower.

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.

Eurozone Continues To Show Signs Of Weakness

The euro was mildly out of favour in the previous session as investors digested yet more weak data for the region. After PMI and inflation figures disappointed earlier this week, IFO business sentiment data undershot analysts’ expectations on Tuesday. Business confidence for Germany fell to 101 in December, down from 102 in November and well below expectations of 101.8. This was the fourth consecutive month of declining business confidence in Europe’s largest economy, fuelling concerns that the eurozone is heading towards an economic slowdown.

Today investors will look towards producer price index (PPI) for Germany. This data provides insight into inflation at wholesale level. Analyst are predicting PPI will fall -0.1% month on month in November. This would be yet another sign that inflation will continue declining and that the economy is slowing.

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