High Debt Level in UK Boost Pound Versus Dollar

Higher than expected consumer debt levels in Britain overshadowed mixed data from the U.S., causing the pound to rally over the U.S. dollar on Thursday. The pound U.S dollar exchange rate rallied higher for the pound from $1.2777 to $1.2890. This is the strongest level for the pound versus the buck since the UK elections in early June.

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.

The pound had already received a boost against the dollar earlier in the week after Bank of England (BoE) Governor, Mark Carney, said an interest rate rise could be a needed. The central bank also highlighted that household debt growth at current levels was unsustainable. With that in mind, Thursday’s consumer credit data was of special interest.

The figures supported BoE’s concerns with consumer debt jumping to £1.7 billion, considerably higher than the £1.5 billion forecasted by analysts. The pound rallied on hopes that BoE will increase interest rates in response to the current high levels of debt.

High interest rates make debt more expensive as interest payments would increase. So raising interest rates is a tool used by the BoE to dissuade consumers from taking on more debt. As bets increase that an interest rate rise could come sooner than the markets had initially thought, the pound rallied.

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.

Whilst UK data has been pleasing investors, U.S. data was more mixed in nature. Jobless claims increased by 4000 – worse than forecasted. However, the trend still points to a tightening labour market. The employment picture in the U.S. is extremely important for an overall insight into the health of the U.S. economy. Whilst the jobless claims has less of an impact than the monthly labour report, it still helps to build an understanding. Higher claims mean higher levels of unemployment. Investors will now look ahead to next week’s monthly labour report for further insight.

The other piece of data in the previous session of interest for the dollar was the GDP. Prior to the release, there had been concerns that the U.S. was heading towards a sizeable slowdown in economic growth. However, the final revision of the GDP was revised upwards to 1.4% from 1.2%, which provided some support for the dollar.

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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