Monday, 3 February 2014

Why has the Pound dropped from €1.22 to €1.2050?

Monday 3rd February 2014 
Since my last post we have seen further volatility in the Pound/Euro exchange rate. On Friday we saw rates hit €1.22, but the spike was short lived as has often been the case in the last few months. In trading today, rates fell quite a bit, falling to €1.2048 at the time of writing. 

In today’s post I’m going to explain what caused rates to rise only to quickly fall back away again. I will also look at what data is due this week that I think will affect exchange rates. 

Pound/Euro hits €1.22 on EU inflation data. 

On Friday we saw some very low inflation figures from Europe, which mean the European Central Bank may take action to help protect the eurozone's fragile recovery. Official figures showed that eurozone inflation fell to 0.7% in January, down from 0.8% in December and further below the ECB's 2% target. 

It has fuelled worries about whether the euro bloc could suffer deflation, potentially de-railing economic growth. As such, the only tool in the ECB’s box to combat this, is cutting the EU interest rate or possible the deposit rate. This would help combat deflation, but due the lower return on offer, it would also weaken the Euro. 

Mario Draghi, president of the ECB, has said that although inflation was "subdued, and expected to remain subdued" for about two years, he was confident that it would return to target. But he added that the ECB was ready to act if necessary. 

It was this comment that hints at lower interest rates in the EU, and we saw this being priced into the market on Friday, and it was this that caused rates to climb to €1.22 as the Euro lost value and became cheaper to buy.

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Why have rates fallen today to €1.2050? 

There are 2 reasons for the drop in rates today. Firstly we saw some better than expected data from Euros. Eurozone manufacturing grew strongly in January on the back of new orders, a closely-watched business survey suggests, with Germany leading the way. This counteracts the bad news we saw on Friday, and so the Euro regained some strength and has become more expensive to buy. 

Also this morning, we saw some poor UK Manufacturing data that was a little lower than expected. This weakened Sterling, and combined with today’s EU data has pulled rates from the high of €1.22 on Friday, to €1.2050 this morning. 

What other data could affect exchange rates this week? 

For Pound/Euro rates, I think that Wednesday and Thursday will be important dats. There are various inflation and Retail Sales numbers on Wednesday, and on Thursday we will see the latest Bank of England (BoE) and European Central Bank (ECB) interest rate decisions. We probably won’t get any surprises from the BoE, however there is a small chance the EU could cut rates. 

I think it’s probably unlikely, but we may see the president Mario Draghi hint at action in the coming months. Either of these things would push Pound/Euro rates higher. 

On Friday we also have some further Manufacturing data from the UK, along with the latest Trade Balance figures. If better than expected then the Pound could gain, but anything that disappoints the market would caused the Pound to fall away quite sharply. 

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