Although there were some sharp fluctuations in the pound/euro exchange rate in October, the currency pair finished the month at similar levels to which it started, writes Ben Scott of FC Exchange.

On October 1st, the GBP/EUR exchange rate was at 1.13, but within the first week the pound fell to 1.11 (Point A), while also shedding 2.5% of its value against the US dollar.

The first week of October saw sterling put in its worst performance in a year and Prime Minister Theresa May experienced a nightmare week as the UK political landscape was shrouded in chaos. The pound stumbled on weak economic data, while May’s political weakness caused many to undermine her Brexit negotiating stance. Rumours of new leadership elections persisted in the market, while May shrugged them off, stating she would continue on with negotiations ‘with full support from the cabinet.’

Brexit continued to make headlines as the month progressed, when Chancellor Phillip Hammond reiterated the risks of Britain’s EU exit, and Chief EU negotiator Michel Barnier stated that a deadlock had been reached regarding the divorce bill.

However, sterling jumped (Point B) on reports that Barnier may be willing to offer a two-year transition period. The pound leapt by over a cent against the US dollar, reaching an eight-day high and reached a three-day high versus the euro, reversing recent declines which had seen it slump to a four-week low against some other majors.

The euro also experienced political fluctuations at the start of October in the aftermath of Catalonia’s independence referendum.

Economic Data

Unsurprisingly, the UK economy produced some positive and less inspiring economic statistics in the month of October as the economy trundles along after the Brexit referendum.

On the positive side, October revealed UK industrial production climbed from 1.1% to 1.6% on the year in the month of August, manufacturing production inched higher from 2.7% to 2.8%, and construction output jumped from 2.7% to 3.5%, despite forecasts for weaker numbers.

UK inflation also rose to reach a 5-year high at 3.0% on the year in September, creating speculation to heighten over whether the Bank of England (BoE) will increase interest rates at its November meeting.

As markets entered November, the central bank chose to increase interest rates for the first time since the Global Financial Crisis (GFC), but the pound fell as they digested the minutes, which stated only gradual increases in monetary policy may take place.

Britain’s budget deficit also dropped to its lowest level in any September in the past decade. UK growth increased by 0.4% in the third quarter which allowed a sterling rally (Point D), slightly better than the 0.3% forecast, but still slow and outpaced by the Eurozone which registered 0.6% in the same quarter. The figure came despite a stronger euro and fears that a stronger currency could impact exporters.

Economist Holger Schmieding commented: ‘It can’t really get much better. Growth is high, unemployment is falling. Strong conditions outside the euro area in the region’s main trading partners have offset any impact from the euro’s appreciation.’

However, UK wage growth came in at 2.2% in the three months through August, meaning that the squeeze on UK households is continuing. As a result, consumer spending slowed, with UK retail sales contracting by 0.8% in the month of September, causing a drag on the pound (Point C).

Unemployment in the Eurozone dropped to 8.9% in September, with significant falls in unemployment in some of the weaker economies such as Greece, Cyprus, and Spain.

Additionally, positive economic data in the Eurozone spurred hopes that the European Central Bank (ECB) would soon begin tapering its quantitative easing (QE) programme. The euro achieved its most impressive weekly rise in over a month on the back of the news. Confidence in the Eurozone climbed by 0.9 points in October to reach 114.2 – the highest level since January 2001 after France, Germany, and the Netherlands enjoyed populist defeats in elections.

Economist Bert Colijin commented: ‘Political tensions continue to have little effect of economic sentiment this year. The surprisingly healthy economy trumps political risks in terms of sentiment for the moment.’

However, while some of the economic data was inspiring, ECB President Mario Draghi was less positive for the euro. Draghi was rather dovish when it came to the topic of tapering the massive sovereign bond buying scheme in place when he made a highly-anticipated announcement. It appears as if the central bank will slowly wean the currency bloc’s quantitative easing (QE) programme, halving the scheme from €60 billion to €30 billion starting from January 2018. Furthermore, Draghi told markets that interest rates would remain low ‘well past’ the end of QE.

Outlook

Economic data following the Bank of England’s interest rate rise will be one of the key factors in influencing the pound exchange rate in coming months.

Speculation as to whether the economy can withstand higher rates surround the November decision and so investors will look toward property market data, consumer spending, and consumer confidence economic statistics and how they translate into economic growth.

Long-term, Brexit has the potential to strongly influence the pound, and it’s hoped that discussions can soon move to trade talks. If that happens, sterling may be offered a reason to strengthen.

Meanwhile in the Eurozone, the situation in Catalonia could cause some volatile GBP/EUR movement should developments deepen, and further positive economic statistics from the currency bloc could boost the euro.

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