GBP/EUR Exchange Rate Drops on Forecast Difficulties with Brexit ‘Backstop’

June 7, 2018 – Written by Ben Hughes

On Wednesday, the Pound to Euro exchange rate opened in the region of 1.1434 but closed down lower around 1.1390.

There was little solid UK economic data out on the day, which instead left Pound Sterling at the mercy of trader reactions to a document from the European Commission.

The document warned EU businesses that they should be aware of that trading with the UK after Brexit might be more difficult.

This was interpreted by some as an explicit message not to do business with British companies after Brexit, which led to the Pound falling in value.

Wednesday’s Eurozone news was mostly positive, with German construction activity and Eurozone-wide retail sector activity being reported higher during May.

Brexit Backstop Confusion Causes GBP/EUR Exchange Rate Losses

The Pound’s (GBP) previous losses against the Euro (EUR) have been extended today, following an unsettling Brexit-related event in Downing Street.

Brexit Secretary David Davis questioned part of the Brexit ‘backstop’, which is a contingency measure to prevent a hard Irish border if all other Brexit negotiations fail.

For Mr Davis, the issue was that the backstop had no time limit, so in theory the UK could remain tied to parts of the EU indefinitely after supposedly ‘leaving’ the multinational union.

Today’s main event has been a debate between Mr Davis and Prime Minister Theresa May, who had verbally backed but not implemented a hard time limit on the backstop.

Early on, there was speculation that Mr Davis could resign from his position in objection to the situation, but the Brexit Secretary has ultimately kept his job.

The backstop now has a more defined end date, although it is still a fairly vaguely-defined termination date so it is unclear if solid progress has actually been made today.

Despite claims that this is a positive development, the Pound has nonetheless fallen against the Euro because of the uncertainty caused by the incident.

Rising Hopes for Tighter ECB Monetary Policy Push EUR/GBP Exchange Rate Up

On the other side of the pairing, the Euro (EUR) has appreciated against the Pound (GBP) thanks to speculation about a European Central Bank (ECB) interest rate hike coming in 2018.

These hopes have been rekindled by recent remarks ECB policymaker Peter Praet, who has suggested that quantitative easing (QE) could be coming to an end in 2018.

Mr Praet has not explicitly suggested this outcome, but has nonetheless led Euro traders to consider a tapering off and wind down of QE as a distinct possibility.

QE is the ECB’s bond-buying program and its continued operation is largely seen as a barrier to ECB officials deciding to hike interest rates from their current 0% level.

The critical moment will be next week’s ECB monetary policy meeting on Thursday, which could lead to solid signs that QE is on its way out this year.

GBP/EUR Exchange Rate Forecast: Will Pound Sterling Recover on Next Week’s Earnings and Inflation Stats?

The Pound (GBP) has struggled against the Euro (EUR) today, but has a chance to regain lost ground next week when high-impact earnings and inflation data comes out.

Before then, however, the Euro could see some late-week movement on Friday’s German trade balance and industrial production figures.

Both data releases could devalue the single currency, opening up the possibility of a GBP/EUR exchange rate rise on Friday.

If the German trade surplus shrinks as expected along with a slowdown in German industrial production levels being reported, the Euro could fall in value.

For Sterling, next week’s earnings and inflation rate readings will respectively be released on Tuesday and Wednesday and might cause the GBP/EUR exchange rate to rise sharply.

The wage growth readings are fairly unambiguous – if the pace of average earnings acceleration rises then the GBP/EUR exchange rate could improve.

A faster pace of wage growth will improve conditions for UK households and might mean that there is an increased likelihood of a Bank of England (BoE) interest rate hike.

The effect of the inflation readings on Pound Sterling is less predictable – a faster pace of inflation would risk a wage squeeze on UK households, but would also put pressure on the BoE to hike interest rates.

As such, Sterling might appreciate on such news – the GBP/EUR exchange rate could also rise if inflation rates slow, however.

In this scenario, UK households would be under less price pressure so there could be increased discretionary spending and a more stable overall economy.

While the BoE wouldn’t be under as much pressure to act, such an improvement for UK households could still raise expectations for a near-term interest rate hike.

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TAGS: Pound Euro Forecasts