28 Feb 2018 | 10.31 am
Markets Insight From IG
Sustained euro/pound stability is a boon for businesses but a bore for traders
28 Feb 2018 | 10.31 am
How long can the euro/sterling stability last, asks Martin Essex (pictured), analyst and editor of IG’s free news and research site, DailyFX.com
For Irish and British businesses trading with each other, the sustained stability of the euro against the pound has been a boon. But for traders, it’s been a bore. In the middle of last year, things were very different. From a low of just above 83p in mid-April, the euro surged ahead to top 93p in late August, only to drop back to less than 88p a month later. Since then, the exchange rate has barely moved: trapped mostly in a narrow range between 87p and 90p.
Such a period of stability might simplify planning for businesses, but for traders, it makes turning a profit considerably harder. So will this period of stability last? At first glance, the lack of movement in recent weeks is surprising. In the UK, interest rates are already climbing, whereas the European Central Bank has said that it will only start to raise rates once it has ended its asset-purchase programme, its preferred method of stimulating the eurozone economy.
That programme is likely to continue until late 2018, meaning that higher eurozone interest rates are unlikely before next year at the earliest. The pound should, therefore, have an advantage, as rates there rise sooner than rates here. Moreover, UK rates are already higher than they are in Germany, France or Ireland, making an investment in sterling-denominated assets more lucrative.
Arguably, therefore, the pound should be rising against the euro. But in neither the UK nor the eurozone have interest rate expectations changed much recently, so it’s possible that the current exchange rate already discounts the later rise in rates. Additionally, there are risks in both the UK and the eurozone.
For the UK, the most obvious one is Brexit, although this seems to have receded as a market concern, despite the continuing lack of progress on issues like the Irish border. For the euro, it’s political instability. In Italy, the success of eurosceptic parties like the Five-Star Movement and the Northern League has emphasised the fact that the euro is not nearly as popular in many European countries as it is in Ireland.
In Germany, Chancellor Angela Merkel’s problems forming a government after the indecisive general election have highlighted how the division of power between the European Commission, the European Parliament and national governments can complicate decision-making and be potentially negative for the currency.
In practice, this means political instability is as much a fear in the eurozone as it is in the UK, where the political future of Prime Minister Theresa May remains under a cloud. If her ruling Conservative Party decides to replace her, or she decides to call a general election, the pound would certainly suffer.
Exchange Rate Influencers
Either way, the current stability of the euro/pound exchange rate seems unlikely to last much longer. One possibility is that a breakthrough in the Brexit negotiations, or further political problems in Germany, Italy or elsewhere, gives the pound a boost. Another is that the ECB will decide to tighten monetary policy sooner than currently seems likely, strengthening the euro in response.
As always, the lesson for traders is to keep a close eye on not just economic data and the charts, but also on monetary policy, geopolitics, sentiment – and all the other factors that go into determining an exchange rate.