Euro Rallies After ECB Comments Pull GBP/EUR Lower

12.01.18
4 minute read
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The euro surged higher on Thursday, as the European Central Bank (ECB) joined the chorus of other central banks that are considering raising interest rates. As a result, the pound euro exchange rate sunk to a low of €1.1221. This is the weakest level that the pound has traded at versus the euro 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.

The pound has had a fairly lacklustre few sessions. A slew of economic data earlier in the week, including news that UK manufacturing output was at a 10-year high, failed to boost the pound. The strength in the manufacturing sector also resulted in the NIESR increasing their 4th quarter GDP estimate for Britain to 0.6% from 0.5%. However, the pound on the whole barely flinched at these encouraging data points.

Despite the stronger than expected data, pound traders remain anxious over the health of the UK economy. Furthermore, they continue to be concerned over the perceived political weakness of UK Prime Minister Theresa May, which is keeping to the mood towards the pound sour.

How does political stability boost a currency?
Political stability boosts both consumer and business confidence, which means corporations and regular households alike are more likely to spend money. The increased spending, in turn, then boosts the economy. Foreign investors prefer to invest their money in politically stable countries as well as those with strong economies. For foreign investors to put their money into an economy, they need local currency. As they acquire the money needed, the demand for that particular currency increases, which then boosts its value.

With no high impact economic data due today, investors will look towards next week. Inflation data, in the form of consumer price index (CPI) could be the biggest driver of volatility for sterling in the near term.

ECB To Tighten Policy Soon?

The euro recovered in the previous session from a lack of demand earlier in the week. The mood for the euro improved on Thursday as investors shrugged off a slightly lower than forecast German GDP and instead focus on the upbeat minutes from the last European Central Bank (ECB) policy meeting. Euro traders interpreted the minutes from the December policy meeting as “hawkish” after the central bank said it will revisit its forward guidance in the new year.

The forward guidance is the term that central banks use to communicate to the market what their monetary policy will be. The idea of the forward guidance is to prevent, where possible, uncertainty and encourage transparency.

The ECB saying that they intend to revisit the forward guidance means that in the coming months the ECB could start to raise expectations of when the central bank will look to tighten policy by ending the bond buying programme, and then raising interest rates.

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.
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