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GBP/EUR: Pound Rises On Brexit Optimism

4th October 2019

Brexit optimism pushed the pound higher versus the euro in the previous session. The pound euro exchange rate rallied to a high of €1.1302 before slipping back towards the close. The pound euro exchange rate closed the previous session 0.2% higher at €1.1246. The pair is advancing in early trade on Friday.

Hopes that a Brexit deal could still be reached helped lift the pound on Thursday, even as data indicated that the UK was heading towards a recession.

Pound investors cheered the fact that Prime Minister Boris Johnson is trying to get a Brexit deal done. Whilst his first effort to compromise is still looking too tough for Brussels to agree to, rumours that Boris Johnson has a plan B are circulating. The PM hasn’t completely ruled out the Irish backstop but with a time limit attached to it. This is some thing that Brussels haven’t formally ruled out either. Hopes of a deal boosted 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.

Any gains were limited as investors digested a hattrick of disappointing PMI data across the week. With less than a month to go until Brexit, the manufacturing, construction and most importantly the service sector are all in contraction. The weak readings across the board indicate that the UK is heading straight for a recession in the third quarter.

Today there is little in the way of economic data. Brexit headlines will continue to drive trading.

Eurozone Retail Sales Lift Euro

The euro was broadly in favour in the previous session, just less so than the pound, thanks in part to stronger than forecast retail sales data and thanks in part to the weaker dollar.

Data from the EU’s statistics agency, Eurostat, showed that retail sales in the bloc increased by 0.3% month on month in August. This was ahead of the -0.6% decline experienced the previous month. On an annual basis retail sale increased 2.1%.

Market participants watch retail sales figures closely, because they consider them to be an indication of future inflation. Strong retail sales tend to indicate stronger inflation later down the line. This is good news for the eurozone which is currently experiencing lacklustre inflation of just 0.9%. Higher inflation means the central bank could be less inclined to cut interest rates.

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.

Also boosting the euro is a weak dollar. The euro trades inversely to the US dollar so when the dollar falls the euro tends to rise. The dollar fell sharply in the previous session as US recession fears grew.

There is no eurozone data today so the euro will trade at the will of the pound or the dollar.

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 GBP = 1.13990 EUR

Here, £1 is equivalent to approximately €1.14. This specifically measures the pound’s worth against the euro. 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.