The pound plummeted over 130 points versus the US dollar on Tuesday. Investors started to doubt whether the Bank of England (BoE) would raise interest rates in November. As a result, the pound US dollar exchanged tumbled to a low of US$1.3180 for sterling.
|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.
Not even UK inflation, as measured by the consumer price index (CPI) which was hitting its highest level in 5 years, was enough to save the pound in the previous session. The cost of living in Britain increased 3% on an annual basis in September, up from 2.9% in August. This is higher than the BoE’s 2% target for inflation and should have encouraged investors to believe that an interest rate rise could be coming in the very near future. This would cause the pound to rally.
|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, BoE Governor Mark Carney dashed hopes of a rate rise soon. He sounded more conservative in an appearance in front of the Treasury Select Committee than he was at the last monetary policy meeting. Furthermore, 2 new BoE policy members have also expressed doubts as to whether they are in fact in favour of a rate rise at this point in time. As a result, the pound dived lower.
Today, the focus will shift to UK employment data, and more specifically wage growth data. Should the data show that wages accelerated faster than the 2% analysts expect, then the pound could rally. This is because stronger wage growth would make the BoE less hesitant to raise interest rates.
The dollar enjoyed broad based support on Tuesday, boosted by strong data. US industrial production rose 0.3% in September, smashing expectations of a fall of -0.7%. This is still a relatively low figure, but distortions from the impact of the summer hurricanes are continuing to show through. Economists expect October Industrial Output data to rebound dramatically as capacity affected by the hurricanes is reopening. Delving deeper into the numbers manufacturing of cars, home electronic and appliances increased which serves as a positive sign for consumer spending.
|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.|
Today 2 US Federal Reserve Officials are due to speak, plus stats on housing and the Fed Beige Book means the dollar could have a volatile session.
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.