Pound Dives Against Euro as Politics Drive the Currency Pair

13.06.17
3 minute read
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The pound has continued to fall versus the euro as politics drive the currency pair. Political uncertainty in the UK following the general election is pushing sterling lower, whilst political success for Macron’s party in Parliamentary elections is boosting the euro higher.

The pound euro exchange rate dropped a further 100 points on Monday, taking the rate from a high of €1.1388 to a day’s low of €1.1281. Sterling dropped past the lowest point reached on Friday immediately following the release of the UK election results.As a lack of political stability weighs, this is the weakest level that the pound has traded against the euro for 7 months.

How does political stability boost a currency?
Political stability boosts both consumer and business confidence, which means corporations and regular households alike are more likely to spend money. The increased spending, in turn, then boosts the economy. Foreign investors prefer to invest their money in politically stable countries as well as those with strong economies. For foreign investors to put their money into an economy, they need local currency. As the acquire the money needed, the demand for that particular currency increases, which then boosts its value.

Investors will continue to watch for any UK political developments, most likely putting economic data releases on the backburner. Under normal circumstances, the release of UK inflation data later this morning would be expected to impact the pound’s current value. However, given the fragile political outlook, investors are expected to focus on when Brexit talks will be beginning and whether the Conservatives can finalise the agreement with the Democratic Unionist Party (DUP).

Euro rallies as Macron succeeds in first round Parliamentary elections

In sharp contrast, the euro is going from strength to strength. French President Macron’s newly formed political party En Marche! performed extremely well in the first round of the French Parliamentary elections. Strong results have bolstered confidence in Macron and, should his party perform well in the second round on 18th June, Macron will then have solid support in Parliament to push through his ambitious economic and political agendas. Analysts are currently forecasting that he could win up to 455 of the 577 seats available.

From a Forex perspective, the euro is looking stable compared to its peers the pound and the U.S. dollar. Firstly, eurozone political risk has significantly subdued for the time being. Secondly, eurozone economic data has been solid. Thirdly, the European Central Bank has been very slowly making signs of moving towards interest rate normalisation. Or, in other words, returning to historically normal levels of 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. So more local currency used then boosts the demand of that currency, pushing its value higher.

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