The pound softened against the euro in July as data painted a less rosy picture for the UK economy, while the Eurozone recovery steamed ahead, writes Ben Scott of FC Exchange.

Data Shows Evidence of UK Slowdown

July was a volatile time for the pound – at the beginning of the month it seemed as if it was gaining some stability, despite several less than inspiring UK ecostats. UK service sector data slowed to a four-month low in June, but sterling managed to stand its ground and make gains against the euro.

Economist Howard Archer commented: ‘Following on from weaker manufacturing and construction surveys, the softer services PMI [purchasing managers’ index] points to an already fragile economy struggling in June as heightened uncertainties about the UK outlook fuel business and consumer caution.’

Since the monumental Brexit vote economists and industry experts have been watching for Britain to start showing signs of a slowdown. A year on, cracks in the UK’s strong facade are becoming more prominent. Archer said that the slowdown was ‘disappointing, but hardly surprising.’

However, as the month went on, the pound was battered by a strengthening euro. One positive for sterling came in the form of US dollar weakness which allowed the pound to breach the 1.30 interbank psychological barrier, to finish the month at 1.31, and begin August in the region of 1.32. The US dollar is likely to remain under pressure as the Federal Reserve appears to be dragging its heels when it comes to another interest rate increase. Additionally, weighing on the greenback is the constant political mess in the White House which seems to be unraveling without an end in sight as Russia’s election involvement is investigated amid changes of staff and the failure of policy implementation.

Central Banks Sway Currencies

One of the big things to take place in July was the heightening of anticipation for monetary policy adjustments by both the European Central Bank (ECB) and the Bank of England (BoE). For the pound, a major disappointment came when BoE member Ben Broadbent failed to mention anything that hinted at higher interest rates after hawkish comments from chief economist Andy Haldane and Governor Mark Carney. GBP/EUR dropped to lows of €1.1274 (point A) on the news.

Shortly after, the pound to euro exchange rate soared (point B) when BoE policymaker Ian McCafferty said now could be the time to raise interest rates.

Draghi Boosts the Euro

The end of June allowed the euro to climb when President Mario Draghi suggested that the economy was strengthening and ‘deflationary forces’ had ‘been replaced with reflationary ones.’

Ears twitched as Draghi’s optimism continued and the ECB President suggested the central bank would look through ‘temporary’ weaknesses in inflation and the euro rose on expectations for the ECB to begin unwinding its loose monetary policy stance.

Following his statement, other ECB officials tried to imply that markets had misunderstood Draghi’s words, and even Draghi’s own dovish comments later in the month failed to dispel market optimism.

In fact, despite his best attempts, the euro rallied to an eight-month high against the pound (EUR/GBP) (point C) and nearly a two-year high versus the US dollar (EUR/USD).

However, Draghi’s in a good position to be shouting about the Eurozone’s successes. The second quarter registered higher growth than the UK and the US, coming in at 0.6% in Q2 and 2.1% on the year. This marked the 17th consecutive quarter of economic growth dating back to 2013. While Spain registered 0.9% growth in the three months through June, France achieved 0.5% and Sweden left other European economies for dust with an impressive 1.7% growth in Q2. In comparison, the UK and the US both registered 0.3%. The UK stat highlights a growing divergence between Britain and other economies post-Brexit referendum.

Additionally, the Eurozone’s labour market is tightening significantly. June’s data showed unemployment dropped to 9.1%, the lowest level in nine years, with 1.5 million leaving the unemployment market in the past year.

Oxford Economics economist James Nixon said: ‘These numbers are at the top of what is possible to be sustained. If you look at the number of jobs that are being created, this is a very impressive performance.’

Populist Defeat Bodes Well for EUR

There’s something else that’s putting the Eurozone in good stead to make a strong recovery—the removal of populist threats. Whereas the US and UK have been plagued with shaky politics, questionable political decisions, and headlines with new developments printed almost daily, the Eurozone has avoided two potentially catastrophic elections. The euro could have fallen dramatically if controversial candidates Geert Wilders or Marine Le Pen had won elections in the Netherlands or France. Since their defeat, politics in the currency bloc have been offered some stability – something Britain and the US can only dream of at the moment.

Outlook

There’s one other major political event on the horizon for the Eurozone in the form of the German federal election on 24th September. Polls indicate that current Chancellor Angela Merkel should comfortably remain in power for a fourth term, which will be another factor to offer the euro exchange rate some support.

Ongoing Brexit negotiations will also play their part in GBP/USD and GBP/EUR movement, but markets will be keeping a close eye on economic data to gauge whether the UK economy is growing slower. Some of the most important pieces of data will be inflation readings, growth numbers, and labour market statistics.

Bank of England decisions and comments are likely to be another major factor in influencing sterling movement as investors hope for further divergence between policymakers in the hope of an interest rate rise. The prospect of interest rate hikes may be one of the only developments to allow the pound to regain some substantial strength versus the strong euro in the near future. However, following the latest Monetary Policy Committee (MPC) meeting at the start of August showing only a 2-6 divergence in attitudes towards rate hikes, it’s unlikely Britain will see higher rates for some time.

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