June has been quite a volatile month for the pound versus the Australian dollar exchange rate. Sterling has weakened by over 4% against the Australian dollar as UK political jitters and economic concerns in the UK weigh on investor sentiment.
The previous session was no different. The pound shed over 0.7% versus the Australian dollar following a speech by the Bank of England (BoE) Governor Mark Carney. The pound Australian exchange rate fell from a high of A$1.6776 for the pound just prior to Mr Carney taking the stage, to A$1.6633 as he began talking.
|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.
Investors sold out of sterling because Carney dashed hopes of an interest rate increase happening any time soon. He felt right now was not the time to hike rates, despite inflation being almost 1% above the BoE target of 2%. Carney pointed to subdued UK wage growth and weak consumer spending as reasons, in addition to noting that the inflation spike is merely temporary and caused by the Brexit-weakened pound. In turn, this has made imported goods more expensive. When the pound strengthens, however, inflation will come down. But in the meantime, consumers are set to suffer the increased cost of living. With hopes of an interest rate hikes dashed, the pound devalued sharply.
|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.
Today will draw investor focus back to Britain’s political uncertainty. Today is the State Opening of Parliament, where Theresa May is due to give the Queen’s Speech. However, she has still failed to form a majority government. A deal with the Democratic Unionist Party (DUP) was meant to have been reached by today, however, there have been reports of problems between the two parties which has prevented a firm deal after a week of talks. Not only does this not bode well for the Brexit negotiations, but also Theresa May will be giving the Queen’s speech with a minority Parliament – potentially pointing to a politically unstable road ahead.
|How does political stability boost a currency?
|Political stability boosts both consumer and business confidence, which means corporations and regular households alike are more likely to spend money. The increased spending, in turn, then boosts the economy. Foreign investors prefer to invest their money in politically stable countries as well as those with strong economies. For foreign investors to put their money into an economy, they need local currency. As they acquire the money needed, the demand for that particular currency increases, which then boosts its value.
Pound weakness has enabled a buoyant Australian dollar to push ahead even further. Investors continued to digest the minutes from the Reserve Bank of Australia’s (RBA) monetary policy meeting. The minutes have supported the Australian dollar, not because the RBA is intending to hike rates, but because they aren’t intending to cut rates any further. Given the central bank’s current concerns over high levels of household debt stemming from rapidly rising property prices, any interest rate hike could be some way off.
This article was initially published on TransferWise.com from the same author. The content at Currency Live is the sole opinion of the authors and in no way reflects the views of TransferWise Inc.