The end of the year was a bumpy one for the pound to euro exchange rate with Brexit and other European political events creating ups and downs in the market, writes Ben Scott of FC Exchange.

Brexit Back to Business?

The GBP/EUR exchange rate began December at interbank levels of €1.13 and closed the month slightly lower in the €1.12 region. There had been a few opportunities to climb, but the second half of the month saw sterling mostly heading marginally lower as markets prepared for the quieter festive season.

Regarding Brexit, December gave markets some clarity; not only were talks able to progress on to trade with some semblance of a divorce agreement on the table, but the UK government was also suggesting the long-awaited discussions would begin right away. The pound rallied on December 7th with the news of trade talk progression, as optimism swept through the market.

However, less positive was EU Chief Negotiator, Michel Barnier, who quickly put a pin in the market optimism. As the EU said a trade deal by March wasn’t realistic, the pound plummeted against other currency majors, including the euro (GBP/EUR). Credit Agricole representative Valentin Marinov commented: ‘This should not come as a huge surprise given the complexity of the upcoming discussions and the need for a transitional period after March 2019. The reaction highlights that people may have gone a bit ahead of themselves buying the pound.’

The pound fell again in December as Barnier said that trade talks could not only take longer, but also be more testing. Additionally adding to sterling’s woes were mixed messages from both sides. After Theresa May said that the next round of talks would begin immediately, EU Commission President Jean-Claude Juncker announced that they would only start in March.

Brexit Banking

Another interesting development in December was the public dispute between Bank of England (BoE) Governor Mark Carney and Michel Barnier. While Barnier stated that significant changes would need to happen in the world of banking after Brexit, Mark Carney noted that the central bank planned to make it simple for EU banks to continue with their operations in the UK. Carney suggested that the BoE wouldn’t be creating any additional regulations or charges.

Meanwhile, in the Eurozone, European Central Bank (ECB) President Mario Draghi caused the euro to soften when he said that monetary policy needed to remain accommodating and that the stimulus measures would stay in place for as long as they were required. However, the central bank did increase its growth and inflation forecasts.

Economic Data to Influence GBP/EUR

One of the most significant pieces of data to be revealed in December was the UK inflation rate. While economists had expected consumer prices to stagnate at 3.0% in November, the actual figure inched up to 3.1%. Also, the Office for National Statistics (ONS) revealed that average weekly earnings had only risen by 2.3% in the three months through October. Real earnings which account for the cost of living, declined by 0.4%, while the average weekly pay packet not including bonuses resided at only £478—the lowest level on record since February 2006. Economist John Hawksworth commented: ‘Real pay levels continue to be squeezed, and we expect this to persist for at least the first half of 2018, further dampening consumer spending growth.’

December’s data release showed UK unemployment levels remained at 4.3% in the three months through October, rather than dropping to 4.2% as predicted. German factory orders slipped more than economists had forecast too. The October reading showed a drop to 6.9% on the year, a shade below the 7.0% forecast, after September’s far more upbeat 9.7%.

The Month Ahead

January has begun with a few disappointments; the Eurozone’s inflation figure dropped to 1.4% in December on the year, from 1.5%, despite there being an upswing in recent economic growth figures from the currency bloc. Meanwhile, UK construction noted its sixth consecutive drop with the December Markit purchasing managers’ index (PMI) coming in at 52.2, rather than the 53.0 prediction. New car registrations also dived, reaching -14.4% on the year in December and marking its most notable fall since 2009.

There have been some positive developments at the open of 2018 too; Germany’s unemployment rate has reached its lowest level since the reunification in 1990, at 5.5% in December. Investors will be closely watching German growth numbers, and other indicators as recent data could spell a positive 2018 lays ahead for the currency bloc powerhouse.

In the rest of the month, there’s room for further political developments as Theresa May has orchestrated a Cabinet reshuffle which had been expected to see the most significant shift in her Cabinet since the disastrous election last year. However, it wasn’t a smooth process and her choice not to create a major shakeup within the senior roles may be seen as a sign of weakness.

Meanwhile, in Germany, Angela Merkel heads for coalition talks once again as the prospect of a snap election which could give further power to populist parties looms.

In central bank developments, the Bank of England (BoE) is due to release its latest Credit Conditions and Bank Liabilities surveys on January 11th, the same day the European Central Bank will release its most recent meeting minutes.

Concerning the pound to US dollar (GBP/USD) and euro to US dollar (EUR/USD) exchange rate prospects, markets have witnessed a weakening of the buck. Towards the end of the year, the US dollar didn’t fare well against a host of other currency majors including the pound and the euro, as a selloff took place. Data emerging in December showed US consumer confidence dropped from a 17-year high and other influential data such as US non-farm payrolls have disappointed in early January. The USD exchange rate had sunk to a three-month low at the start of the year, as speculation that investors may find global reflation trade more appealing in the year ahead.

Ben Scott
Foreign Exchange Ltd
www.fcexchange.co.uk