Pound Dives Versus Australian Dollar Ahead of BoE Rate Decision

The pound Australian dollar exchange rate tumbled 1% on pound weakness as fears over the state of the UK economy in addition to political uncertainty weighed on trade. The exchange rate is approaching the A$1.6729 low hit in the wake of the UK general election results, where the UK Conservatives failed to increase their majority in Parliament.

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.

Against a backdrop of an unstable political environment in the UK, investors are working themselves through a busy week as far as economic data releases are concerned. On Wednesday, there was more bad news for the UK consumer after wage growth fell to 2.1%, which was worse than analysts predicted. That makes it average earnings’ lowest level in the UK since late 2014. Given that inflation soared to 2.9% in May, that means wages in real terms (i.e adjusted for inflation) are actually falling. And falling faster than analysts had expected. As the cost of living increases, consumers are finding an intensifying squeeze on their paychecks. This could cause households to hold back on spending, which is bad news for the economy. Britain’s economy is heavily reliant on the service sector, which requires consumers to spend. When concerns emerge over an economy’s health, the currency will fall. Which it what is happening to the pound.

Why does poor economic data drag on a country’s currency?
Weak economic indicators point to a slowing economy. Weak economies have weaker currencies because institutions look to reduce investments in countries where growth prospects are low and then transfer money to countries with higher growth prospects. These institutions sell out of their investment and the local currency, thus increasing supply of the currency and pushing down the money’s worth. So, when a country or region has poor economic news, the value of the currency tends to fall.

Today’s release of retail sales figures will provide evidence as to whether households are reining back on spending. Up to now, retail sales have remained fairly resilient with the UK consumer continuing to spend. However, given the extent of the squeeze on households, a drop in retail sales could be on the cards. Should retail sales growth come in lower than the 1.7% expected, the pound could continue to crumble versus the Australian dollar.

Finally, the Bank of England (BoE) will also be enlightening the market with an interest rate decision today. The rate is expected to stay on hold at 0.25%. Investors will be listening carefully to BoE Governor, Mark Carney, for any clues as to when interest rates may rise. Inflation is well above the BoE target of 2%. However, given the huge squeeze the consumers are experiencing on top of the already uncertain atmosphere created by a hung UK parliament, rates could stay on hold for quite some time. Confirmation of this by Mark Carney could also bring interest rate expectations lower, which would weigh on the value of the pound.

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.

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