The euro has weakened significantly against the dollar over the last 24 hours as investors digest comments from the European Central Bank (ECB). The euro U.S. dollar exchange rate dropped almost 100 points from a high of $1.1269 to a level of $1.1180 on euro weakness, its lowest level in a week.
|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 ECB meeting had mixed results. On the plus side, the ECB signalled they probably wouldn’t cut interest rates again. In addition, the central bank also raised growth expectations for the region. However, the euro was more focused on the fact that the central bank also cut inflation forecasts. The ECB now anticipates inflation to hit 1.5% in 2017, 1.3% in 2018 and 1.6% in 2019. The forecasts remain stubbornly below the ECB inflation target of 2%. A central bank is unlikely to raise interest rates whilst inflation is below target levels. The fact that the ECB doesn’t see inflation moving above the target level for over three years essentially suggests that the ECB won’t be considering hiking interest rates for some time yet. When interest rate expectations for a country fall, the currency falls - which is what is happening with the euro.
|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. So more local currency used then boosts the demand of that currency, pushing its value higher.|
The key risk event for the dollar in recent sessions was the appearance of James Comey, the recently fired, ex-FBI Director. As he appeared before the U.S. Congress, the main takeaway from his speech was that President Trump didn’t officially act in a way to warrant impeachment. The dollar has viewed this as a positive because it doesn’t add yet another layer of uncertainty. Furthermore, Comey’s appearance hasn’t created too much additional controversy - it seems there was very little new information over Comey’s past interactions with Trump. This is good news for the dollar because the President will not be busy fighting fresh political storms, distracting him from progressing with his dollar boosting economic agenda - an agenda which includes tax cuts and huge fiscal spending plans.
With Comey’s appearance safely out of the way, investors will now be looking ahead to the Federal Open Monetary Committee (FOMC) meeting next week. The financial markets are placing a 96.8% probability on an interest rate rise from the Fed next week. This would highlight the difference in monetary policy between the Fed and the ECB, potentially offering further support to the dollar.
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