Pound vs US Dollar Dominated by Central Bank Action

The pound U.S. dollar exchange rate had a volatile session for sterling on Wednesday as UK political instability, poor UK economic data and the British central bank action influenced the exchange rate.

Big swings in price movements saw the currency pair move over 0.5% in a short period of time on three occasions. The day’s high hit $1.2814, whilst the low for the day was $1.2724 as investors reacted to data released on both sides of the Atlantic. Which, for GBP, was worse than what analysts had predicted.

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 = 1.28934 USD

Here, £1 is equivalent to approximately $1.29. This specifically measures the pound’s worth against the dollar. If the U.S. dollar amount increases in this pairing, it’s positive for the pound.

Or, if you were looking at it the other way around: 1 USD = 0.77786 GBP

In this example, $1 is equivalent to approximately £0.78. This measures the U.S. dollar’s worth versus the British pound. If the sterling number gets larger, it’s good news for the dollar.

Investors have had a barrage of influential UK data to digest this week. Today was no different with UK wage data highlighting concerns over the squeeze that the UK consumer is experiencing. The cost of living is increasing, whilst wages, once adjusted for inflation, are falling.

Today sees the release of retail sales data, which will act as evidence as to whether the consumer is actually holding back on spending. Given the dominance of consumer spending in the UK economy, any signs of weakness could impact heavily on the pound. A figure of less than 1.7% growth will raise concerns and could send the pound even lower.

Finally, the Bank of England (BoE) will be the at the centre of attention today. The central bank is forecast to keep current interest rates on hold at the historically low level of 0.25%. Investors will be paying particular attention to BoE Governor, Mark Carney, for any hints as to when the central bank could start tightening monetary policy. Inflation, at almost 3% in May, is far higher than the bank’s 2% target. Investors will be keen to see if the central bank is close to its upper limit of tolerance, which could mean a hike is on the cards sooner rather than later. Increased interest rate expectations tend to boost a currency, which is why the pound is seeing some support.

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.

U.S. Fed hikes rates as expected

In a tale of two central banks, the U.S. Federal Reserve increased the U.S interest rate as analysts expected. The central bank was also more upbeat in its pursuant statement than what the markets had been anticipating. Reference was made to economic growth “rising moderately this year” whilst the weaker inflation data in the U.S. was downplayed. All in all, the market has upped its interest rate expectations for the rest of the year which, in turn, has boosted the buck.

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