The pound softened 0.4% against the euro during the previous week. European Central Bank (ECB) policy caution and Brexit created some volatility, which saw the pound trade up at weekly high of €1.1418 before falling to a weekly low of €1.1287. The pound has started the new week marginally higher versus the euro.
|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 EU officially declared that sufficient progress had been made in the 1st phase of Brexit talks to move onto phase 2. The 2nd phase would focus on a transition deal and the future relationship between the EU and Britain after Brexit. The pound actually tumbled steeply on the news, as EU officials also confirmed that trade talks would not begin until March. This will make an already tight timetable, even tighter raising doubts over whether a trade deal will be reached in time to prevent a hard Brexit.
|Why is a “soft” Brexit better for sterling than a “hard” Brexit?|
|A soft Brexit implies anything less than UK’s complete withdrawal from the EU. For example, it could mean the UK retains some form of membership to the European Union single market in exchange for some free movement of people, i.e. immigration. This is considered more positive than a “hard” Brexit, which is a full severance from the EU. The reason “soft” is considered more pound-friendly is because the economic impact would be lower. If there is less negative impact on the economy, foreign investors will continue to invest in the UK. As investment requires local currency, this increased demand for the pound then boosts its value.|
This week the UK economic calendar is quiet, which means that focus will remain on Brexit. UK Prime Minister Theresa May will discuss with her cabinet how they view the post Brexit relationship with the EU. Theresa May is politically weak right now and these discussions could bring domestic political tensions to the surface, which could unnerve pound traders and send sterling lower.
Last week the euro came under some pressure following the ECB meeting. Although the central bank impressed with an upgrade to economic growth, the ECB disappointed investors with its inflation forecast. Despite strong economic growth, the ECB still don’t expect inflation to hit the 2% target level by 2020. Forecasts suggest inflation will only reach 1.7%. This dashed any hopes of the ECB tightening monetary policy and raising interest rates in the next few years. As a result, the euro softened.
|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.|
Today investors will remain firmly focused on inflation as the inflation figures for November are due to be released. Analysts are expecting the cost of living on an annual basis to has risen from 1.4% to 1.5%. Should this be the case, demand for the euro could increase as investors slightly adjust their odds of the ECB tightening monetary policy.
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