Pound Rallies Against the Dollar as Chances of a UK Rate Hike Increase

Strong economic data from the UK data supported the pound on Tuesday, pushing the pound US dollar exchange rate higher. The exchange rate climbed 0.5%, crossing back over US$1.32 for sterling for the first time in 5 days. This is the second straight session of gains for the pound versus the dollar, after it rallied from US$1.3032 at the beginning of the week.

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 US 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 US dollar’s worth versus the British pound. If the sterling number gets larger, it’s good news for the dollar.

The general outlook for the pound remains weak thanks to lingering domestic political issues and concerns over Brexit. However, some good news in the form of UK manufacturing and industrial production data was enough to send sterling higher. The data showed that industrial output grew at 1.8% annually in August, doubling analyst’s forecasts of 0.8%. Meanwhile, manufacturing production output increased at 2.8% smashing forecasts of 1.9%, and hitting its highest level of growth since February. The strong data has increased speculation that the Bank of England will vote to raise interest rates at the next central bank monetary policy meeting in November.

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.

However, gains in the pound were capped as the International Monetary Fund (IMF) cut its growth forecast for the UK. At the annual meeting of the IMF and the World Bank, the IMF said that the negative effects of Brexit were starting to show through in the UK economy. It expects Brexit to continue weighing on the British economy over the coming years. This would make the UK an exception in an otherwise strengthening global economic outlook. There was no knee-jerk reaction to this prediction from pound investors, however a weaker outlook from the IMF could keep gains in the pound in check.

Why does poor economic data drag on a country’s currency?
Slowing 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.

Dollar traders await the Fed minutes

Overall, the outlook for the dollar is strong. The market is currently pricing in on an 85% probability of a US interest rate hike in December, which is providing support for the buck.

Today, investors will look towards the US Federal Reserve minutes from the policy committee meeting in September. If the minutes show that the Fed still has confidence in the US economy and supports an increase in interest rates, then the dollar could reverse its two-day decline. Given that odds for a rate hike are so high, the risk is to the downside. However, any comments showing hesitation towards raising interest rates could weigh on the dollar heavily versus the pound.

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