Expectations that the European Central Bank (ECB) will adopt a more dovish stance on monetary policy sent the euro southwards on Thursday. Meanwhile signs of strength in the US economy lifted the dollar. As a result, the euro US dollar exchange rate plummeted to a low of US$1.1092. The pair continues to hover around these levels in early trade on Friday.
|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 EUR = 1.12829 USD
Here, €1 is equivalent to approximately $1.13. This specifically measures the euro’s worth against the dollar. If the U.S. dollar amount increases in this pairing, it’s positive for the euro.
Or, if you were looking at it the other way around:
1 USD = 0.88789 EUR
In this example, $1 is equivalent to approximately €0.89. This measures the U.S. dollar’s worth versus the euro. If the euro number gets larger, it’s good news for the dollar.
The euro sunk sharply in the previous session and remains out of favour amid ongoing recession fears and following comments from ECB policy maker Olli Rehn.
Earlier in the week German GDP figures showed that Europe’s largest economy contracted in the second quarter as it remains caught up in the US — Sino trade war. Investors fear that with no end to the US — Sino trade dispute in sight, the German economy could slip into recession in the third quarter of the year. A recession being two consecutive quarters of contraction. If Germany is in recession, the eurozone as a whole could also tip into recession.
Given the weakness surrounding the German and eurozone economy, the European Central Bank are growing increasingly nervous. ECB policy maker Olli Rehn yesterday stated the importance of outlining a “significant and impactful” stimulus package in September. Rehn pointed to the weakening German economy as justification for aggressive monetary easing, which could include rate cuts. The prospect of a rate cut sent the euro lower.
|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.|
US Consumers Are Still Spending But Is Confidence Waning?
Concerns over the health of the US economy eased on Thursday following the release of stronger than forecast US retail sales data. US retail sales jumped 0.7% month on month in July. This was well above the 0.3% than city analysts had forecast. Fears surrounding the state of the US economy amid the ongoing US — Sino trade war have dominated this week. Strong retail sales data shows that the US consumer remain unaffected by the trade dispute, this is a relief given the importance of the US consumer to the US economy.
|Why does strong economic data boost a country’s currency?|
|Solid economic indicators point to a strong economy. Strong economies have strong currencies because institutions look to invest in countries where growth prospects are high. These institutions require local currency to invest in the country, thus increasing demand and pushing up the money’s worth. So, when a country or region has good economic news, the value of the currency tends to rise.|
Today investors will look towards the US consumer confidence data. Analysts are predicting that consumer confidence has ticked lower. This could weigh on demand for the dollar.
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