The pound US dollar experienced a very volatile session on Wednesday. Higher US inflation dragged the exchange rate lower, before suddenly reversing direction, sending the pound US dollar from a low of $1.3800 to a session high of $1.4011.
|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 was out of favour early on in the previous session. With little in the way on high impacting economic data, investors focused firmly on Brexit headlines. UK Foreign Secretary and Brexit hardliner, Boris Johnson, was the first of series of UK senior Brexit ministers who will be giving key speeches over the coming days, laying out how the UK sees the EU UK post Brexit relationship. The speech lacked substance, giving little further insight as to what the UK was aiming for. Furthermore, some key issues such as the Irish border issue was completely ignored. UK Prime Minister Theresa May is due to speak at the weekend. Any signs that the UK is looking to distance itself from the EU could cause the pound to drop.
|Why is a “soft” Brexit better for sterling than a “hard” Brexit?
|A soft Brexit implies anything less than UK’s complete withdrawal from the EU. For example, it could mean the UK retains some form of membership to the European Union single market in exchange for some free movement of people, i.e. immigration. This is considered more positive than a “hard” Brexit, which is a full severance from the EU. The reason “soft” is considered more pound-friendly is because the economic impact would be lower. If there is less negative impact on the economy, foreign investors will continue to invest in the UK. As investment requires local currency, this increased demand for the pound then boosts its value.
The US dollar rallied hard midway through the previous session after US inflation data beat analysts expectations. Headline Consumer Price Index (CPI) remained constant in January at 2.1%, above analysts forecast of 1.9%. Meanwhile core inflation which excludes more volatile items such as food and fuel also remained constant at 1.8% whilst analysts had predicted a fall to 1.7%. These figures confirmed the markets thoughts that the US is entering a higher inflation environment. This means that policy makers at the Federal Reserve are more likely to take a more aggressive approach to tightening monetary policy. As investor expectations for higher interest rates increased, so did the value of the dollar.
|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.
Also driving the dollar higher, were fears over the higher interest rate environment dampening growth. Given the safe haven status of the dollar, investors looked to wards the dollar.However, quite abruptly mid-session, these fears evaporated and the dollar sharply reversed direction.
Today, sees another full day on the US economic calendar which could result in another volatile session. The most noteworthy data releases will be the jobless claims and industrial production.
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.