Pound Traded Higher Versus the Euro as Draghi Manages Taper Talk Expectations

TransferWise content team
04.09.17
3 minute read

As last week came to a close, the pound was trading at its strongest level versus the euro in almost a fortnight at €1.0925. Whilst UK economic data offered some support to sterling, concerns over the upcoming European Central Bank (ECB) meeting ensured the euro remained under pressure.

The pound was boosted on Friday by data that showed that the UK manufacturing sector expanded at the fastest pace in four months in August. The weaker pound was helping to boost manufacturers competitiveness, with growth in domestic and export new orders driving production by the most in seven months. The manufacturing purchasing managers index rose to 56.9 in August, up from 55.1 in July. This data supports hopes that the UK economy can rebalance itself from an economy supported primarily by the consumer, to an economy which has a larger base from manufacturing. The news was cheered by investors which sent the pound higher.

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.

Today investors will be turning their attention to see whether the UK construction sector is holding up under the strain of Brexit. City analysts are expecting the construction sector to have expanded fractionally more in August. However, some analysts are doubtful that the sector was able to perform up to expectations in August given the uncertainty over the UK economy caused by Brexit. If the data fails to meet analysts forecast, the pound could come under pressure.

ECB push back expectations of tapering

Meanwhile the mood for the euro plummeted on Friday. Rather than being caused by any weakness in eurozone data, the drop was the result of increasing uncertainty over the ECB monetary policy meeting to be held on Thursday. Speculation had been rife that the ECB would announce plans to taper its current bond buying programme at the September meeting. The winding down of such a programme is considered a form of tightening of monetary policy and a prelude to raising interest rates. When investors expect monetary policy and interest rates to increase the currency receives a boost.

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.

However, ECB President Draghi reined in those expectations on Friday and October is now looking more plausible for such an announcement. As a result, demand for the euro dropped.

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