EUR GBP Exchange Rate Shrugs Off Dip in German Business Optimism

December 19, 2017 - Written by Tim Boyer

STORY LINK EUR GBP Exchange Rate Shrugs Off Dip in German Business Optimism

The latest market worries over Brexit and the UK’s future trade relationship with the EU helped the Euro Pound exchange rate to trend higher on Tuesday.

Demand for Sterling weakened markedly on the back of the latest comments from chief EU negotiator Michel Barnier, who ruled out the possibility of London's financial sector maintaining its passporting rights.

This would deal a significant blow to the City, encouraging more banks and financial institutions to relocate jobs and infrastructure to cities within the EU.

Given the significant role that the financial sector plays within the UK economy this prospect naturally weighed heavily on GBP exchange rates, stoking fears over the domestic outlook.

While Eurozone construction output was found to have slowed on the month in October this failed to particularly dent the gains of the EUR GBP exchange rate.

EUR Exchange Rates Bullish in Spite of Weaker German Business Sentiment

Markets were also quick to shrug off the disappointing nature of December’s German IFO business sentiment surveys, which showed unexpected weakness.

Particularly notable was the sharp decline in the business expectations measure, which slumped from 111 to 109.5 on the month.

This dip is likely to be the result of the collapse in coalition talks seen in November, with the sense of political uncertainty having spooked some businesses.

However, markets remain largely confident that the ultimate impact of the political situation is likely to be short-lived, with the German economy expected to maintain much of its momentum over the coming months.

As Carsten Brzeski, Chief Economist at ING, commented:

‘Today’s Ifo index was the last important economic data coming out of Germany this year. Only December inflation data to be released on 29 December could get markets’ and ECB watchers’ attention. The Ifo index marks the end of a remarkable year for the German economy. A year ago, consensus forecasts for German growth were around 1.5% for 2017. Now, GDP growth is likely to come in at around 2.5%.’

Even so, the EUR GBP exchange rate may struggle to hold onto its gains on Wednesday with the release of the latest German producer price index figures.

Forecasts point towards a slight easing in inflationary pressure in November, suggesting that the European Central Bank (ECB) is likely to maintain its more dovish bias for some time to come.

On the subject of Eurozone inflation, analysts at Rabobank noted:

‘Our super core measure, which excludes value-added taxes and government administered prices stood at 0.85% in November, where industrial ex-energy goods inflation accelerated slightly, but this being mostly offset by slightly lower service sector inflation. The only conclusion one could draw from recent numbers is that underlying inflation pressures remain extremely subdued, even more so than one would expect.

‘Next months’ HICP data may confirm whether or not that has been due to transitory factors. One thing to highlight, though, is that the package holidays component in the HICP returned to 3.9% YoY in November from a low reading of 1% in October. In other words, without this component, core inflation would have been 0.8%.’

All in all, the odds of the ECB imminently returning to a tightening bias still look rather slim at best.

Weaker Retail Sales to Weigh on GBP Exchange Rates

Demand for the Pound could pick back up in the short term, though, if Bank of England (BoE) Governor Mark Carney makes positive comments in his latest appearance.

Focus will also fall on the CBI reported retail sales measure for December, which is expected to show a slight decline on the month.

Fresh signs of weakening consumer spending could lead to further softening of GBP exchange rates, suggesting that households are increasingly feeling the impact of the wage squeeze.

As consumers have been integral in driving economic growth in recent months a weak showing here could weigh heavily on the appeal of Sterling.

Any developments regarding Brexit could also provoke volatility for the EUR GBP exchange rate, with markets still distinctly sensitive to the issue.

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TAGS: Euro Pound Forecasts