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Sterling/Euro Exchange Rate Review May 2018

Friday 08 June 2018

May was choppy for the pound to euro exchange rate as markets digested Bank of England developments, Brexit news, and important economic data, writes Ben Scott of FC Exchange.

Highs and Lows

The pound had days where it appeared to be approaching the interbank €1.15 level, yet also days when investors questioned just how low it would go. At the start of May, the pound came under pressure when political jitters and Bank of England (BoE) speculation shook the market.

As the month went on, the pound continued to experience softness when dovish Bank of England comments came to light.

On May 10th, the bank chose to keep interest rates on hold, which caused the pound to slump against the euro.

While this was no huge surprise to markets given recent economic data, the BoE also revised its growth forecasts lower. Its 2018 estimates suggest that UK growth will reach 1.4%, rather than the healthier 1.8% forecast in February. BoE Governor Mark Carney indicated that although Brexit had been a drag on business investment, it hadn’t intensified. He also stated that the bad weather had been a key factor in Britain’s economic slowdown.

Five Star Politics

Meanwhile, in the Eurozone, Italian and Spanish politics also created some significant doubts in the market. Populist parties the Five Star Movement and the League banded together to form a coalition in Italy, but it wasn’t a smooth journey. There was speculation as to whether Italy would host another election later in the year, but on the first day of June, the new Eurosceptic coalition government was sworn in. At the helm is Giuseppe Conte, a law professor with no background in politics.

The party has some big plans a reduction in migrants, an earlier age to retire, and cuts in taxes. In the past, the Five Star Movement has suggested Italy should have an EU referendum of its own; any resurgence of that thought could drag the euro lower.

In Spain, June began with a vote of no confidence for Prime Minister Mariano Rajoy, who was ousted with 180 votes to 169.

Economic Data

The UK’s construction sector finally noted an upswing in April’s purchasing managers’ index (PMI) coming in at 52.5 from the previous month’s 47.0. Any figure above 50.0 denotes growth, a figure below indicates the sector is contracting.

May also revealed a higher number of people were in employment in the three months through March on the year. While wages including bonuses fell from 2.8% to 2.6%, the number of people in work jumped above forecasts, coming in at 197K. By the end of the month, on May 25th, the UK had posted the worst quarterly gross domestic product (GDP) growth figures for five years, with expansion dropping to just 0.1% in the first quarter.

Meanwhile, in the Eurozone, the euro was offered little favour when the latest gross domestic product (GDP) number came in at 2.5% on the year in the first quarter. Germany’s growth numbers showed only 0.3% expansion in the first quarter, pulling the annual figure down from 2.9% to 2.3% on the year. The months of coalition talks in Germany following the last election are cited as one of the negative factors contributing to weaker growth. German factory orders missed their 5.0% forecast, edging up from 3.0% to 3.1% in March on the year, while investor confidence in the Eurozone slipped from 19.6 to 19.2.

Customs Division

Controversy over the customs union created divisions between Theresa May and her MP’s, with questions posed about whether the UK could remain in the customs union until 2021, or even beyond.

The week commencing May 15th saw the GBP/EUR exchange rate fluctuate between levels of 1.1342 and 1.1471 as back and forth reports reached markets as to whether the UK would remain in the customs union.

To add to the pressure on the UK government ahead of the June Brexit summit, Irish Prime Minister Leo Varadkar commented: ‘If we are not making real and substantial progress by June then we need to seriously question whether we’re going to have a withdrawal agreement at all.

GBP/EUR Forecast

The Bank of England is due to release its 12-month inflation forecast, which could provide markets with an excuse to move the exchange rate. Central bank projections and comments have been very influential for sterling this year, amid a backdrop of other central banks such as the US Federal Reserve, which is in a rate hike cycle.

On May 22nd, the pound advanced after BoE representative Gertjan Vlieghe said that the UK could experience up to six interest rate hikes in three years, but economic data will need to support the Monetary Policy Committee (MPC) should they look to hike rates.

Additionally, the upcoming Brexit summit could be revealing and create fluctuations in the sterling to euro exchange rate. The currency pair could fluctuate if continued uncertainty surrounding the UK’s exit from the European Union continues.

In the Eurozone, there has been speculation that a slow-down could be taking place as some pieces of economic data do underwhelm the markets. Germany, the powerhouse of the currency bloc, has produced some lacklustre ecostats in recent months and if this continues investors are likely to become concerned that it’s not just a temporary slowdown.

Ben Scott
FC Exchange

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