GBP/EUR: Pound Could Sink Lower If No Progress In Brexit Talks Made

06.11.17
4 minute read
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Despite all the excitement and volatility in the previous 7 days, the pound actually closed only 41 points lower versus the euro last week. After climbing early in the week, the pound fell sharply on Thursday to a low of €1.1189 before tentatively climbing across Friday. The pound euro exchange rate finished the week at €1.1265 for the pound.

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.

The pound sold off heavily after the Bank of England (BoE) hiked interest rates, but failed to convince investors that it was anything more than a one-off action. This means that the possibility of another rate hike has been pushed further into the distance, which pulled the value of the pound lower.

Why do raised interest rates usually 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.

This week could start rather slowly for the pound, given that there’s no high impacting economic data due on Monday. Investors will need to wait until mid-week for an influential economic indicator in the form of retail sales. UK retail sales data could provide an insight as to how the British consumer is managing in an environment of rising prices and falling wages in real terms. Signs of weakness in consumer spending on retail goods could pull the pound lower.

Brexit makes a return to the spotlight this week. Thursday sees EU Chief Negotiator Michel Barnier and UK Brexit Secretary David Davis begin another round of negotiations. Investors will be paying close attention to any developing headlines, after Michel Bernier warned over deadlock at the end of the previous round of talks, in October. Talks must progress by the end of the year for there to be any chance of a transition deal being struck.

Will Eurozone Inflation Start To Tick Higher?

After a quiet previous week as far as influential eurozone economic data was concerned, this week sees a slightly busier economic calendar. Today there are 2 data releases of significance. Firstly, the composite PMI which looks at the services and manufacture sectors in the eurozone. The PMI indicates the health of a sector by looking at five indicators: new orders, inventory levels, production, supplier deliveries and the employment environment. Analysts forecast that the sectors will report solid expansion. Should the data reach expectations then the euro could rally.

Why does strong economic data boost a country’s currency?
Solid economic indicators point to a strong economy. Strong economies have strong currencies because institutions look to invest in countries where growth prospects are high. These institutions require local currency to invest in the country, thus increasing demand and pushing up the money’s worth. So, when a country or region has good economic news, the value of the currency tends to rise.

The other data point of interest will be the eurozone producer price index (PPI). This is a measure of inflation at wholesale level. The eurozone is suffering from very low inflation, which is refusing to move higher. The European Central Bank (ECB) has made it clear that they want to see inflation move higher before they consider hiking interest rates. Should the PPI figure come in higher than the 0.4% predicted by analysts, the euro could rally. This is because a higher level of PPI inflation could increase the perceived odds of a rate rise in the future.

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