Why has the Pound fallen? It’s to do with inflation numbers. Sterling has taken another knock today, after the UK’s latest inflation figures came in below forecast, reducing the chances of the Bank of England raising interest rates any time soon. As rates will be left at 0.5% for some time to come, it has put the Pound on a weaker footing against the other major currencies. GBP/EUR has fallen into the €1.13’s, and GBP/USD has fallen to fresh lows of $1.33 – more than 10 cents lower than a few months ago.
Why does inflation affect the Pound?
Lower inflation is good for consumers, as it now means that wages are growing faster than prices, but in terms of the currency markets, it’s all to do with speculation on when interest rates will rise. The prospect of higher interest rates usually strengthens a currency due to the higher return on offer for investors, spurring them to purchase the currency concerned. The US Dollar is a case in point; they are forecast to raise rates several more times this year and as a result, the USD is stronger and more expensive to buy.
With inflation falling, the BoE don’t need to raise rates any time soon, and that’s the main reason for the Pound struggling. There are also Brexit concerns, and this coupled with a run of weak data from the UK has sent the Pound lower.
Will the Pound go back up against the Euro?
In the short-term, this largely depends on tomorrow’s Retail Sales numbers, and Friday’s GDP estimate. In the long-term, it’s all about getting the Brexit deal sorted out.
Our short term view is GBP/EUR in a range of €1.13 to €1.15. Our long term view is more optimistic, with rates likely to recover to €1.20 once there is more clarity over Brexit.
Retail Sales are a good indicator of how the overall economy is growing. The last release was very poor, but as my colleague Michael pointed out yesterday, this was probably due to the inclement weather and snow keeping consumers indoors. The markets expect an increase of 0.7% tomorrow; if the number matches or exceeds this, then there is the potential for the Pound to claw back some ground. On Friday, GDP is expected to come in at 0.2%. Again, a higher reading would be positive for Sterling.
We also have a speech by the BoE governor Mark Carney. In my view he is usually very pessimistic about the economy and his comments often send the Pound lower.
Just yesterday he said that the vote to leave the EU had caused households to become poorer by £900 per year, confirming his pessimistic outlook. This is despite the fact that pre-referendum predictions of a recession have not come to pass. Indeed the economy has performed much better than expected, and has remained resilient. Borrowing is at its lowest in over 10 years, employment is at its lowest since 1975, wages are growing, and UK exports have risen to a record high.
So with the economy doing rather well, why isn’t the Pound?
It all comes down to one word: Uncertainty. The lack of any progress with regards to Brexit negotiations is keeping the Pound weak. Sooner or later, a deal will be struck between the EU and UK with regards to customs and trade. When this happens, I expect GBP/EUR to climb back to €1.20. In the short-term however, I think this pair will remain stuck in a range between €1.13 and €1.15. Even Mark Carney admits that once Brexit clarity is here, there will be a surge in business investment and this should also help the Pound.
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