GBP to EUR Conversion Higher as US Fed Signals New Higher Rates Era

The pound to euro pair traded to its best exchange rates in the wake of news the US Federal Reserve is looking to raise rates. But why is the GBP/EUR a winner?

The pound sterling gained on its European counterpart on observations that interest rates are likely to start rising in the United States as early as December 2015.

The US Federal Reserve Open Markets Committee (FOMC) today indicated that the first interest rate in years is close having removed reference to the threats posed by a global slowdown.

One would expect the US dollar exchange rate complex to rally on news that US interest rate yields will rise.

It turns out the British pound is also a significant winner of the news.

Sterling shot higher against the euro with the pound to euro exchange rate bouncing off 1.3820:

Above: Sterling shows intent in the immediate aftermath of the release of the October FOMC statement. The GBP to EUR conversion is now trading around its best levels since August.

Why is the Pound Higher?

Interest rates matter - those countries seen to be in the process of raising interest rates command a stronger currency.

Global money flows to where yields and thus returns on that currency are higher, in the process pushing up the home currency.

The US and the UK are the two major economies due to benefit from higher yields.

So while the Fed has left the door open to delay its first rate hike even further, if things turn out to be weaker than expected, "the statement supports our view that FOMC is on track to raise rates at its upcoming meeting in mid-December. We continue to expect a 25bp hike," says Harm Bandholz, Chief US Economist at UniCredit Research.

This is important for the British pound.

The Bank of England historically moves after the US Federal Reserve, so news that the US Fed is now heading to a rate rise opens the door to a similar move at the Bank of England.

The euro is a loser because the European Central Bank is headed in exactly the opposite direction. We have heard this October that the ECB is lining up another potential interest rate cut, which could come as soon as December.

This divergence in interest rates is what matters and on this basis we could well see the GBP to EUR exchange rate test its 2015 best once more.