Pound vs Euro to be Driven by Politics & Central Banks In The Week Ahead

23.10.17
4 minute read
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The pound rallied strongly versus the euro into the weekend. Sterling’s strength came after Thursday’s EU leaders summit saw a slight softening in the stance of the EU towards UK over Brexit. As a result, the pound euro exchange rate soared upwards 1% from a low of €1.1087. The pound continued to show strength heading into the new week. Sterling is trading at €1.1208, its strongest level since last Wednesday.

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.

At the summit last week, the EU leaders said that insufficient progress had been made in Brexit negotiations to progress to talks over trade deals and a transition period. However, the EU also noted that they will begin internal preparations for the second phase of the talks. Investors have viewed this as a positive message and one that also diminishes the possibility of no deal being reached. Any sign that a transition could be agreed upon is beneficial for the pound and, for this reason, the pound rallied versus the euro.

Why is a smooth Brexit good for the pound?
A smoother Brexit would be a scenario in which the economic consequences of leaving the European Union are minimised. This is favourable for the pound because the less the Brexit impact on the economy, the more likely that foreign investors will remain interested in the UK. Foreign investors need sterling to invest in the country and so the more GBP is purchased, the higher the demand and, thus, an increase in the currency’s value.

Politics aside, investors are also looking forward to the Bank of England (BoE) monetary policy meeting on the 2nd of November. The central bank has hinted that they may raise interest rates at this meeting. This week sees the final release of the third quarter Gross Domestic Product (GDP) release. GDP is the total value of everything produced by all the people and companies in the country and is the best way to measure a country's economy. Analysts are forecasting that the UK economy grew 1.5% year on year in the third quarter. If the readings come in lower than expectations, it may unnerve the BoE. The central bank said they would consider raising rates if the UK economy continues to show resilience. Therefore, a lower GDP reading could prevent them from raising the interest rates possibly until next year. In this case, the pound could fall.

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.

ECB ready to taper vs. Catalexit

The euro is being driven by 2 conflicting factors. Firstly, Catalonia has been a major political risk factor for the common currency. The region’s attempt to become independent resulted in the Spanish central government triggering Article 155 of the constitution; which effectively removes some or all of the semi-autonomous powers from the states. Over the weekend, Catalonia’s leader has said that the region will not accept direct leadership from Madrid.

Entering into the new week, the euro is lower versus the pound. However, it is finding some support from investors looking towards the European Central Bank (ECB) monetary policy meeting on Thursday. Investors and analysts alike are expecting the ECB to announce the tapering off of its bond-buying programme. Through the bond-buying programme, the ECB purchases bonds in the market. Investors who would have considered the bonds then cannot because the ECB acquired them instead. Those investors still have money to invest so they must choose other investments. That is how the ECB pushes liquidity into the economy. This is considered a form of tightening of monetary policy, therefore it undermines the currency.

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