The collapse of German coalition talks saw the Pound Euro exchange rate trending sharply higher at the start of the week, creating fresh political uncertainty to drag the single currency down.
Investors were naturally spooked as the Free Democratic Party walked away from the table, raising the risk of a fresh general election and the departure of long-standing Chancellor Angela Merkel.
This creates the potential for further turmoil within the currency union, with Germany looking likely to remain tied up in domestic politics for some time to come.
As the German producer price index also slowed on the year in October, dipping from 3.1% to 2.7%, this added to the bearish mood of the single currency.
Commentary from various European Central Bank (ECB) policymakers is unlikely to offer EUR exchange rates any particular support in the near term, as the tone looks set to remain predominantly dovish.
However, the Euro could find some support later in the week if November’s raft of Eurozone manufacturing and services PMIs prove solid.
So long as the currency union continues to post signs of robust growth this should limit the upside potential of the GBP EUR exchange rate, with the Eurozone continuing to strongly outpace the UK economy.
GBP Exchange Rates Set For Volatility on UK Budget
While speculation started to pick up in anticipation of Wednesday’s Budget announcement the mood towards the Pound nevertheless improved.
There is optimism that the UK could be moving closer to some manner of breakthrough in Brexit negotiations, even though time for a transition deal is fast running out.
The latest developments in Germany could also improve the case for an extension of the March 2019 deadline, something which would be highly supportive to Sterling.
However, the key source of volatility in the coming week is still set to be Chancellor Philip Hammond’s Budget.
Although Hammond has little real room for manoeuvre here, given the weaker state of the UK’s finances, investors are interested to see the general tone of the announcement.
As Viraj Patel, Foreign Exchange Strategist at ING, noted:
‘GBP investors may need to look beyond the minutiae of policy detail in the Budget this week and focus on the degree of economic optimism struck by the Chancellor – especially as this may be fairly indicative of how close the UK government is to breaking through the Brexit impasse. Reports that the Cabinet will back PM May’s increased Brexit bill offer is indeed good news for GBP bulls.’
If Hammond fails to offer a more upbeat tone, though, this could return the GBP EUR exchange rate to a weaker footing.
Current GBP EUR Interbank Exchange Rates
At the time of writing, the Pound Euro exchange rate was making solid gains in the region of 1.1237. Meanwhile, the Euro Pound exchange rate was slumped around 0.8897.