The pound surged in late trade on Tuesday amid reports that the UK and EU were closing in on a draft Brexit deal. The pound spiked to a five-month high of €1.1592 versus the euro. The pair is slipping lower in early trade on Wednesday.
The pound surged in the previous session following reports that the EU and the UK were zooming in on a Brexit deal. Talks continued late into the night and an agreement remains in sight. However, Boris Johnson is yet to convince the Northern Irish DUP of the deal, even offering cash payments to bring them onside. Talks will continue. Germany and France have warned that it could take months to iron out the details, meaning that a Brexit extension may be needed.
| 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. |
Brexit will remain the key driver of the pound today. Investors could briefly look towards UK inflation figures. Analysts expect inflation to tick higher to 1.8% year on year in September, up from 1.7% in August. Higher inflation could push back investor expectations of a BoE rate cut, boosting the pound.
Eurozone Inflation To Drag On Euro?
The euro traded marginally lower in the previous session despite improved sentiment in the eurozone and in Germany. The closely followed ZEW sentiment data showed that investor sentiment in German declined by less than what analysts were expecting in October. The ZEW survey of market financial experts found that sentiment deteriorated in October to -22.8 from -22.5 in September. This was significantly better than the —27 that investors had expected.
The ZEW indicator has rebounded from -44, an 8-year low in August, providing some glimmers of hope that Germany may just avoid a recession this year. That said, the reading is still gloomy on a historical basis.
Today the euro could come under pressure as investors look towards eurozone inflation data. Inflation in the bloc has been lacklustre and analysts are not expecting an improvement today. Analysts expect inflation to remain at 0.9%, well below the European Central Bank’s 2% target. When inflation is low the central bank may consider cutting interest rates in an attempt to boost inflation.
| 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. |
| 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. |
