The pound US dollar exchange rate traded flat as it opened on Sunday evening at US$1.3133 for the pound. Yet, despite the calm start, volatility could pick up through the week as investors look towards central bank decisions from both the Bank of England (BoE) on Thursday and the US Federal Reserve on Wednesday.
|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.
Last week data showed that the UK economy grew faster than what analysts had been forecasting. The UK GDP came in at 0.4% quarter on quarter, enough for investors to increase the odds of the BoE hiking interest rates. Pound traders will now look towards the BoE monetary policy committee (MPC) meeting on Thursday. There the central bank could vote to hike rates by 0.25% to 0.5%. Investors are putting the probability of a rate hike at 80%, which means that should the rate hike not occur, then the pound could fall.
|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.
Leading up to Thursday’s decision, analysts are expecting the pound to be shaky. Any signs of weakness in economic data released between now and then could send sterling lower. This is because investors will be concerned that weaker economic readings could encourage the central bank to postpone the interest rate rise until next year. Today, consumer credit data and mortgage approval data will be released. Consumer credit is simply a loan that a financial institution such as a bank grants to consumers for the purchase of goods or services. Mortgage approval data, as the name suggests, reflects the number of loans approved for purchase of a house. These are usually considered medium impact data points. However, given the expected increased sensitivity of the pound leading into Thursday’s rate decision, there could be increased volatility surrounding their release.
The dollar was in demand at the end of last week, after data showed that the US economy grew by more percentage points than what analysts had anticipated. Third quarter US GDP was 3% on an annual basis, significantly above the 2.6% analysts had pencilled in. Strong data sent the dollar higher.
|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.
This week promises to be action packed for the dollar. Firstly, investors will be looking towards the US Federal Reserve monetary policy decision on Wednesday. While no interest rate hike is expected until next month, investors will be listening carefully in anticipation that the tone of the central bank remains encouraging for a hike in December. The other principal focus will be the US jobs report due on Friday. This is often the highlight of the US monthly economic calendar and can potentially swing the US dollar market to a considerable degree.
Meanwhile, investors are also awaiting President Trump’s announcement for a replacement for Fed Chair Janet Yellen. Reports are pointing to governor Jay Powell being the leading candidate. Analysts view him as the continuity candidate, since his approach to monetary policy appears to be very similar to that of Janet Yellen. The dollar could find this a comforting decision. Should Trump appoint Mr. Powell, the dollar may give a small cheer to the investors.
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.