Dollar Steady Against the Pound Ahead of U.S. Retail Sales & Inflation Data

Thursday was a quiet day as far as economic releases were concerned for both the UK and U.S., but rhetoric from policymakers on both sides of the Atlantic more than made up for the shortfall.

The pound finished Thursday 0.2% higher versus the dollar at €1.2940, close to the day’s high at €1.2955. Sterling has had several sessions of gains after spending most of June and a good part of July below $1.29.

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 received a boost in early trading on Thursday when Bank of England (BoE) policy maker Ian McCafferty waded into the monetary policy debate in the UK. McCafferty spiced things up by saying that the BoE should begin winding down its current bond buying stimulus programme (Quantitative Easing or QE). The BoE currently holds £435 billion in government debt, the majority of which is government bonds, brought during the financial crisis using newly printed money.

The unwinding of this programme is expected to push up the cost of borrowing. The BoE had previously suggested that it would not begin unwinding until interest rates were back up at 2%. This would indicate the stimulus was set to continue for some time yet given that interest rates are still only at 0.25%. His comments served to increase interest rate expectations, thus pushing the pound higher.

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 there nothing on the economic calendar for the UK meaning that news flow from the U.S. is more likely to drive movement in the pound-dollar exchange rate.

Inflation data in focus after a more upbeat speech by Yellen

Despite a strong pound, the dollar was also finding support as investors focused on Federal Chair Janet Yellen’s second day of Testimonies before Congress. This time however, she stuck to a more upbeat assessment, hinting the U.S. economy was on the mend. She focused on unemployment to prove her point, dismissing low inflation as a temporary factor which will correct itself over time thanks to low unemployment.

How does strong jobs data boost the currency?
It works like this, when there is low unemployment and high job creation, the demand for workers increases. As demand for workers goes up, wages for those workers also go up. Which means the workers are now taking home more money to spend on cars, houses or in the shops. As a result, demand for goods and services also increase, pushing the prices of the good and services higher. That’s also known as inflation. When inflation moves higher, central banks are more likely to raise interest rates, which then pushes the worth of the currency higher.

The main release today is the U.S. inflation data, in the form of the Consumer Price Index. This could give the markets some insight as to how temporary current inflation issues are. Analysts have pencilled in an increase in inflation on a monthly basis of 0.2%.

Retail sales will also be under the spotlight and a similarly weak reading is expected as a lack of spending still plagues the U.S. economy.

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