Disappointment By ECB Pushes Pound Euro Rate Higher

18.08.17
3 minute read
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The pound euro exchange rate pushed higher in the previous session after finding support from stronger than expected UK retail sales and a more conservative European Central Bank. Heading into Friday, the pound euro exchange rate is trading at €1.0976.

News that UK retail sales in July grew faster than what city analysts had forecast, briefly boosted demand for the pound. Retail sales increased 0.3% in July, this is still a significant decline from the previous month's’ growth of 0.6%, as strains on the consumer show through.

Prices have been on the increase as the falling value of the pound since Brexit feeds through the system. Wages, on the other hand have failed to rise as quickly as inflation, meaning that the consumer is being squeezed. Consumer spending had defied expectations and had actually held up well through the year since the Brexit referendum. However, cracks are starting to appear as the strain on the consumer prolongs.

Retail sales are considered a key indicator of the health of the UK economy. The fact that the figure was better than anticipated boosted the pound. However, given that the figure was noticeably lower than the previous month ensured that the rally was short lived.

Why does poor economic data drag on a country’s currency?
Slowing economic indicators point to a slowing economy. Weak economies have weaker currencies because institutions look to reduce investments in countries where growth prospects are low and then transfer money to countries with higher growth prospects. These institutions sell out of their investment and the local currency, thus increasing supply of the currency and pushing down the money’s worth. So, when a country or region has poor economic news, the value of the currency tends to fall.

Pound traders will now look towards UK GDP data next week for further clues on the health of the UK economy.

ECB minutes pull the euro lower

Demand for the euro weakened following the release of the minutes from the latest European Central Bank (ECB) meeting. The minutes highlighted the central bank’s unease over the strength of the euro. The principal concern is that the euro's strength is hampering the ECB’s efforts to increase inflation. This is because the stronger a currency is, the cheaper imports are, which means the cost of living (inflation) drops.

Inflation in the eurozone remains stubbornly low at 1.3%, a good distance from the ECB’s target level of 2%. A strong currency could make reaching the 2% target an almost impossible job.

Investors interpreted the comments as a clue that the central bank may be planning to leave its loose economic policy in place for an extended period of time. In effect the comments reduced interest rate hike expectations, which weighed on the euro.

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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