Pound Climbs Versus Euro on Soft PMI's

06.09.17
3 minute read
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The pound climbed steadily higher versus the euro in the previous session, as investors digested weaker than expected data from both the UK and the eurozone. Investors brought into the pound sending it to a high of €1.0930, an increase of 0.6% on the day.

After a strong manufacturing report and a weak construction report, investors looked towards service sector growth, as measured by the purchasing managers index. The service sector grew in August at an index of 53.1, slightly lower than the 53.5 level expected. The sluggish growth comes as a result of rising inflation and lacklustre wage growth squeezing the consumer. Consumer industries such as restaurants, gyms, hairdressers, etc were the hardest hit in the report. The service sector is responsible for around 80% of economic activity in the UK so signs of a sluggish growth could be expected to weigh on the economic growth figures for the quarter. Normally weak data would pull the pound lower. However, disappointment from eurozone figures prevented this from happening.

Looking ahead, the UK economic calendar for today is very light. Instead investors will be watching any developments regarding Brexit, either in Brussels or in Westminster, ahead of the Repeal Bill vote on Thursday.

Attention begins to shift to ECB

The euro was out of favour on Tuesday as investors reacted to softer than expected economic data from the eurozone. There’s no doubt that the overall economic picture for the eurozone remains firm, however the measure of activity did actually drop slightly in August. The composite pmi slipped from an index of 55.8 in July to 55.7 in August, with the service sector particularly under pressure. As a result, euro investors sold out of the common currency.

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.

Nerves are starting to show ahead of the European Central Bank (ECB) policy meeting on Thursday. Whilst no rate change is expected, investors are fearing that President Draghi could focus on discussing the problems associated with the high value of the euro, almost in a bid to talk its value down. Tightening monetary policy usually raises the value of a currency. If the ECB are concerned that the euro’s value is already too high, then any tightening of policy through interest rate rises or tapering of the bond buying programme, could be some way off. Should Draghi adopt this approach then the euro could tumble further as the perceived odds of a rate rise decrease.

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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