GBP/EUR: UK & Eurozone Inflation Under the Spotlight

17.10.17
4 minute read
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The pound climbed against the euro during the morning trading session on Monday., hHowever, by the afternoon it was trading noticeably lower. The pound rose to a high of €1.1291 versus the euro, before diving to a low of €1.1227 for sterling towards the end of the day.

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.

Brexit headlines pulled the pound lower as UK Prime Minister Theresa May held talks with French President Emmanuel Macron and Irish Prime Minister Leo Varadkar, in a diplomatic push to try to ease the stalemate in Brexit negotiations with the EU. Theresa May is trying to soften the stance of the EU leaders before Thursday’s EU leaders summit. The drop in the pound came as investors were seeing it as increasingly unlikely that the UK will get the go ahead to move to stage 2 of the Brexit negotiations. This means discussions over a post-Brexit transition deal are being pushed back or could never happen at all.

Today sees UK economic data come into the spotlight once again. The pound rallied strongly when, last month, the Bank of England (BoE) hinted that it could hike interest rates in the near future. Inflation data today could be supportive of such a hike. Analysts are forecasting that UK inflation will come in at 3%, significantly above the 2% target the BoE sets for inflation. The central bank are increasingly uncomfortable with such high levels of inflation. A reading above the 3% forecast could see the pound rally, as the odds for a rate hike increase.

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. More local currency used then boosts the demand of that currency, pushing the value higher.

Inflation data in focus as Spanish political unrest continues

The mood towards the euro was generally weak, albeit stronger than the mood towards the pound. Political risk from Spain continues to weigh on investor sentiment for the single currency. Following the Independence Referendum in Catalonia last week, the Catalan regional President Carles Puigdemont has refused to clarify whether he has declared independence for the region or not. Madrid have now given the Catalan leader until Thursday to back away from declaring independence or face direct rule from Madrid under article 155 of the constitution. Article 155 allows Madrid to suspend regional autonomy. This is looking increasingly probable, but it would mean heading into uncertain political territory which could cause more unrest going forward.

How does political risk have impact on a currency?
Political risk drags on the confidence of consumers and businesses alike, which means both corporations and regular households are then less inclined to spend money. The drop in spending, in turn, slows the economy. Foreign investors prefer to invest their money in politically stable countries as well as those with strong economies. Signs that a country is politically or economically less stable will result in foreign investors pulling their money out of the country. This means selling out of the local currency, which then increases its supply and, in turn, devalues the money.

Today will see investors looks towards eurozone inflation data as a welcomed distraction from the political upheaval in Spain. Eurozone inflation is still failing to pick up, causing concern among European Central Bank policy makers. When inflation moves higher, central banks are more likely to raise interest rates, which then pushes up the currency’s worth.

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