Euro Drops Against Pound Following ECB's Soft Inflation Outlook

15.12.17
4 minute read
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The pound climbed higher versus the euro, on Thursday, as investors digested two central bank announcements and strong UK retail sales data. The pound euro exchange rate pushed through €1.14 for the pound, climbing to its highest 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 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.

UK retail sales convincingly beat analysts’ forecasts and boosted the pound. Sales in November jumped 1.5%, far higher than the 0.2% analysts had predicted and significantly higher than October’s revised 0%. These figures show that the UK consumer is still spending, despite rising prices and falling wages in real time. This is good news for the economy. However, it is worth noting that this high figure could have been helped by one-off Black Friday spending. Retail sales figures are notoriously volatile. One strong month does not necessarily mean a new trend has been formed.

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.

Following impressive retail sales data, the Bank of England (BoE) rate decision was a non-event. The central bank kept interest rates on hold, as expected. The BoE also acknowledged the Brexit deal, saying that it would make a disorderly Brexit less likely. However, it didn’t change interest rate expectations on the back of the Brexit deal, so the pound barely budged.

With no high impacting data on the UK economic calendar, investors will look towards Brussels for any further developments on Brexit.

ECB Boosts Growth Projections – Inflation Disappoints

The European Central Bank (ECB) also kept interest rates on hold, as analysts and investors had predicted. The central bank increased growth projections for the bloc substantially, to 2.4% in 2017 from 2.2% and to 2.3% in 2018, from 1.8%. Projections for inflation were also increased, but only slightly, hitting 1.7% in 2020. This is still below the central bank’s 2% target. Euro traders were disappointed that the increase in strength of the eurozone economy is not translating into higher inflation as quickly as they would like. This means that any form of interest rate rise could still be years off.

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.

The eurozone economic calendar is also very quiet today, leaving investors to look towards inflation data on Monday. After the disappointing inflation outlook from the ECB yesterday, investors will be particularly keen to see whether it is ticking higher.

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