GBP/USD: UK Inflation Remains Steady

Not even weaker than expected UK inflation data was able to prevent the pound US dollar exchange rate from rising on Tuesday. However, the stronger rate was more closely linked to dollar weakness than any pound strength. Heading towards the close the pound US dollar exchange rate hit a day’s’ high of US$1.3187 before it eased back to close at US$1.3165 for the pound.

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 pound initially dropped lower in the previous session as investors dealt with the news that UK inflation remained steady at 3%. Analysts had forecast inflation climbing to 3.1% on an annual basis in October, up from 3% in September. The softer figure meant that investors had to adjust their expectations for an interest rate rise. Lower inflation means any interest rate rise is less likely in the near future.

The Bank of England (BoE) raised rates at the beginning of this month and failed to convince the investors that they intended to raise rates again in the future. This combined with weaker than forecast inflation figures means investors don’t anticipate any future rate rises for an extended period.

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 UK wage data could cause some volatility for the pound. Analyst are anticipating that wage growth will have fallen to 2.1%, down from 2.2% in the previous month. This would mean that the squeeze on the UK consumer’s expenditure is intensifying and households could continue to withhold their spending. This would be bad news for the UK economy. Should the wage data be weaker than this forecast, the pound could fall.

Dollar Dive Despite Encouraging Data

The dollar was weaker across the board in the previous session. The selloff in the dollar came as investors chose to ignore sound economic data, as it was undermined by political uncertainty.

Concerns over delays in the US tax reforms have been weighing on sentiment for the dollar since the beginning of the week. So much so that investors couldn’t even force a rally when producer prices showed an unexpected increase in October. The producer price index (PPI) is a measure of inflation at factory level. Low inflation, despite strong economic growth and low unemployment has been a mystery for the US Federal Reserve throughout the year. Usually, a strong economy would boost inflation. Higher inflation levels tend to increase the odds of an interest rate rise. When the probability of an interest rate rise increases so does the currency.

However, it appears that investors are choosing to wait and see what today’s data brings. Inflation, as tracked by the consumer price index (CPI) and retail sales for the same month will both be under the radar of investors.

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