The pound strengthened against the Australian dollar, regaining almost all of the lost ground from Monday’s session. The pound is currently trading at higher at A$1.6910 versus the Aussie dollar, although it is still trading 1.4% lower than levels from before the UK general election.

What do these figures mean?
When measuring the value of a pair of currencies, one set equals 1 unit and the other shows the current equivalent. As the market moves, the amount will vary from minute to minute.

For example, it could be written: 1 GBP = 1.72119 AUD

Here, £1 is equivalent to approximately A$1.72. This specifically measures the pound’s worth against the Australian dollar. If the Aussie dollar amount increases in this pairing, it’s positive for the pound.

Or, if you were looking at it the other way around: 1 AUD = 0.57677 GBP

In this example, A$1 is equivalent to approximately £0.58. This measures the Australian dollar’s worth versus the British pound. If the sterling number gets larger, it’s good news for the Aussie dollar.

On Tuesday, the pound was able to forget about recent political turmoil following the UK general election. Instead, investors focused on news that Britain’s inflation was at 2.9%, the highest level in four years. Just prior to the Brexit referendum last year, inflation was struggling at 0.3%. Following Brexit, the pound weakened, which meant imports were more expensive which then pushed inflation higher. Following the data release, the pound rallied as hopes increased that the Bank of England (BoE) will consider hiking interest rates in order to keep inflation in Britain under control.

Why do raised interest rates boost a currency’s value?
Interest rates are key to understanding exchange rate movements. Those who have large sums of money to invest want the highest return on their investments. Higher interest rate environments tend to offer higher yields. So, if the interest rate or at least the interest rate expectation of a country is relatively higher compared to another, then it attracts more foreign capital investment. Large corporations and investors need local currency to invest. More local currency used then boosts the demand of that currency, pushing the value higher.

Although, it’s worth remembering that the BoE previously said they’re willing to look beyond this spike in inflation – which they believe is temporary. With the BoE meeting on Thursday, investors will be keen to see if the central bank is still willing to look through inflation which is almost 3%; 1% higher than the bank’s target level of 2%.

With inflation skyrocketing, UK wage data will be of particular interest today. Analysts are expecting average earnings in Britain to have increased 2.4% annually. With inflation at 2.9%, this would mean that wages are actually falling in real terms, which could result in households holding back on their spending. Given the UK economy’s reliance on the consumer, a slowdown in household spending could be detrimental for economic growth. Should the wage growth come in lower than 2.4%, the fragile recovery in the pound could come under heavy pressure.

Australian dollar weaker as two confidence scores miss forecasts

Meanwhile, demand for the Aussie dollar was weakening after two key confidence scores came in lower than analysts were expecting. Both the business confidence index and today’s consumer confidence index disappointed. When confidence in an economy drops, businesses are less likely to invest and individuals are less likely to spend — both bad news for economic growth. A weaker economy will mean a weaker currency, which is what is happening with the Australian dollar now.

Why does strong economic data boost a country’s currency?
Solid economic indicators point to a strong economy. Strong economies have strong currencies because institutions look to invest in countries where growth prospects are high. These institutions require local currency to invest in the country, thus increasing demand and pushing up the money’s worth. So, when a country or region has good economic news, the value of the currency tends to rise.

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