The pound dropped lower versus the US dollar on Tuesday after UK inflation data missed expectations. The pound US dollar exchange rate moved lower and hovered around $1.40, a key psychological level.
|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.
Data from the Office for National Statistics showed that inflation in the UK was finally easing lower. After 5 months of elevated inflation at 3% or higher, inflation, as measured by the Consumer Price Index (CPI) finally pulled lower. CPI printed at 2.7% in February, lower than the 2.8% predicted by analysts, whilst core inflation which removes more volatile items such as food and fuel, increased at 2.4% year on year, below the 2.5% anticipated, whilst falling rom 2.7% the previous month.
This pulling back in inflation will give the Bank of England some breathing space. The Bank of England had increased interest rates in November in an attempt to control runaway inflation. The central bank was considering raising interest rates again in May. However, weaker than forecast inflation will man that they can comfortably sit on their hands and wait to see how the inflation picture develops, before jumping into any course of action. As the possibility of a rate rise was pushed back, the pound dropped.
|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 investors will look towards labour data and more particularly average wage data to see whether the gap between wages and inflation is closing. Should the numbers show the gap is closing the pound could receive a boost.
The dollar traded steadily higher in the previous session as investors look cautiously optimistically ahead to the Federal Reserve’s interest rate decision at 18:00 GMT today. Analysts are widely expecting the Fed to hike rates by 25 basis points. In fact, the market is assuming a 94% probability that the Fed will hike rates.
Market participants will be particularly interested to see whether the Federal Reserve will keep the current forecast of three rate hikes across the year, or whether the Fed under new Chair Jerome Powell will look towards a more aggressive path of rate hikes. Any increase in the number of rate rises forecast for the year ahead could boost the dollar.
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.