Bank of England (BoE) Governor Mark Carney gave a sharp boost to the pound, which rallied strongly versus the Australian dollar. The strong pound pushed the GBP/AUD exchange rate higher by 1% to a peak of A$1.7043. This is the highest level for the rate since the UK elections at the beginning of June. However, the pound was unable to hang onto the gains as the Australian dollar received a boost from soaring iron ore prices. The exchange rate ticked lower to A$1.6927 at the time of writing.
|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.
The pound soared after a spectacular U-turn from Mark Carney, who said that an interest rate rise may actually be necessary. Carney went on to explain that should the global recovery continue gaining momentum leading to a revival of investment into the UK and higher wages, an interest rate increase would be needed. This is a significant turnaround from his position just one week ago when Carney said, in no uncertain terms, that this was not the right time for an interest rate hike.
Interest rate expectations have been on the rise in the UK since the latest BoE monetary policy committee meeting, in which 3 of the 8 policy makers voted for a rate rise. When the markets start to believe that interest rates could be on the rise soon, the currency will receive a boost. This is what happened to sterling yesterday.
|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 economic data comes back into focus in the form of UK consumer credit. Given that the BoE said on Tuesday that it is increasingly concerned over the level of consumer debt, today’s data could attract more attention than normally attributed to the mid-tier (mid importance) reading. A higher figure for consumer debt could trigger a sell off in sterling. This is because fears would grow that the BoE may hold off from raising interest rates if it believes too many consumers would be caught out on higher repayment charges. This in turn would trigger a wave of debt defaults which is bad news for the economy.
On the other side of the equation, the Australian dollar was propelled higher against most of its peers on the back of soaring commodity prices. The price of iron ore rallied another 4% which in turn strengthened the Australian dollar, also known as a commodity currency. The price of iron ore has now surged 10% in just two days. Given the close links between iron ore and the Australian economy, when the price of iron ore rallies, the Australian dollar also tends to rally.
|Why does the price of iron ore impact the Australian dollar?
|The reason behind the impact is because commodities, particularly iron ore, make up the bulk of Australian exports. Ultimately, Australian iron ore needs to be purchased using Australian dollars. So if the demand or expected demand for iron ore increases, then demand for the Australian dollar also increases. As the demand for the Australian dollar goes up, so does its value.
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.