The euro plunged on Tuesday versus the pound as the European Central Bank (ECB) President, Mario Draghi, gave a speech at the ECB forum in Sintra, Portugal. The pound euro exchange rate gained to hit a peak of €1.1228.
|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. 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 GBPIn 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 the pound moved higher versus the significantly weaker euro, the pound moved lower versus its peers. Brexit and the Tory leadership contest continue to be the key drivers for the pound.
Last night the Conservatives had the second round of voting for the Conservative leader. Each of the remaining 6 candidates had to achieve a minimum of 33 votes to stay in the race. Dominic Raab was the only candidate not to achieve this. Boris Johnson won 126 votes, up from 113 in the first round. Meanwhile Rory Stewart gained momentum up from 19 votes to 37. The results continue to show that a no deal Brexit is an increasingly likely outcome given Boris Johnson’s support of leaving the EU with or without a deal.
|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 pound investors will continue digesting last night’s results, whilst looking ahead to inflation numbers due for release. Analysts predict that UK inflation fell in May to 2%, down from 2.1% the previous month. Should this be the case, the pound could fall lower. With inflation dropping lower the Bank of England are likely to adopt a more cautious stance when they meet on Thursday.
The euro was under pressure in the previous session after ECB President Mario Draghi gave the clearest signal yet that the ECB stand ready to launch another round of stimulus if needed. Draghi, who was speaking at the ECB forum, highlighted that economic indicators for the eurozone pointed to “lingering softness”. The weaker economy stems from geopolitical factors and the ongoing trade dispute which have weighed on the export sector and the manufacturing sector, two important drivers of economic growth within the eurozone.
|Why do interest rate cuts drag on 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. Lower interest rate environments tend to offer lower yields. So, if the interest rate or at least the interest rate expectation of a country is relatively lower compared to another, then foreign investors look to pull their capital out and invest elsewhere. Large corporations and investors sell out of local currency to invest elsewhere. More local currency is available as the demand of that currency declines, dragging the value lower.|
Draghi’s comments came as German ZEW sentiment index plummeted in June. The key gauge of expectations for the German economy fell to -21.1, 19 points below analysts forecasts of -5.9. The sharp decline in confidence coincides with increased concerns over the health of the global economy and amid weak German economic data at the start of the second quarter.
There is no high impacting eurozone economic data due for release today. This means that the euro could trade to the tune of the pound or the dollar.
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