Recession fears in Europe and stronger than expected UK inflation data lifted the pound versus the euro on Wednesday. The pound euro exchange rate advanced 0.2% to close at €1.0821. This was the first session this week that the pair closed above €1.08. The pair is drifting lower in early trade on Thursday.
| 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 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. |
It has been a good week as for UK economic data this week. On Tuesday data showed that UK wages grew at the fastest pace in 11 years and yesterday, inflation beat analysts’ forecasts. Inflation as measured by the consumer price index (CPI) unexpectedly pushed above the Bank of England’s 2% target, reaching 2.1% in July. Analysts had pencilled in a decline to 1.9%. The increase in inflation came despite the central bank forecasting that inflation will decline to 1.6% by the final quarter of this year.
The value of the pound increased following the inflation data. This is because with inflation above target, the BoE are more likely to consider hiking interest rates, rather than cutting 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. |
Today investors will be looking at UK retail sales. Analysts are expecting retail sales to fall -0.2% month on month in July, down from the 0.9% increase the previous month. A better than forecast reading could be supportive of the pound. This is because economists consider strong retail sales to be an indication of stronger future inflation.
German economy contracts
The euro dropped in the previous session after data confirmed that the German economy contracted in the second quarter by -0.1%. The data comes following a barrage of weak readings from Europe’s largest economy including industrial output falling by -1.5% in July. The US — Sino trade war has been a key driver in the decline of the German economy as both the US and China are huge export markets for Germany. The fear is that if Germany falls into recession, then it could drag the rest of Europe down with it.
With eurozone economies in contraction and fears of recession looming, the European Central Bank could be more inclined to adopt a more dovish stance. The prospect of looser monetary policy sent the euro lower.
Today there is no eurozone economic data. Investors will continue to focus on the prospects of a recession.
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