The pound slipped versus the dollar in the previous session as investors reacted to UK inflation numbers. The pound US dollar rate dropped sharply following the release to a low of US$1.4173 before paring some losses towards the close.
|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 tumbled in the previous session as investors dealt with data showing that UK price growth slowed in March to the slowest rate in a year. Rather than prices increasing by 2.7% as analyst had forecasted, they increased by just 2.5%. This is the second straight month that inflation has declined, and investors are nervous that the Bank of England (BoE) could put off a Spring interest rate rise. As a result, the pound fell.
|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.|
Yet, the falling interest rate level towards the central bank’s 2% target level is also good news for the UK economy. This is because with wage growth moving higher an inflation decreasing, the consumer is in a stronger position. A stronger consumer will be more willing to spend, which is essential for the UK economy which is so dependent on the service sector.
After UK wage data and inflation data have caused disappointment, market participants will look towards retail sales data due for release today. Analysts are expecting retail sales to have increased 1.4% year on year in March, up from 1% in February. Stronger retail sales figures would indicate that the consumer is spending more. This is a positive sign for the economy and could boot the pound.
The US dollar has traded broadly lower against most of its peers over the last few weeks. This has been down the fears over US- Sino trade wars and concerns over souring US — Russia relations over the bombing of Syria.
However more recently these concerns have eased. China and the US appear to be talking behind the scenes to come to an agreement without entering a trade war. Meanwhile US Russian tensions are easing as Trump backtracks on further sanctions on Russia.
|How does political risk have impact on a currency?|
|Political risk drags on the confidence of consumers and businesses alike, which means both corporations and regular households are then less inclined to spend money. The drop in spending, in turn, slows the economy. Foreign investors prefer to invest their money in politically stable countries as well as those with strong economies. Signs that a country is politically or economically less stable will result in foreign investors pulling their money out of the country. This means selling out of the local currency, which then increases its supply and, in turn, devalues the money.|
Instead, the attention has shifted back towards solid US economic data. Earlier this week, US retail sales climbed, housing starts were also noticeably higher and industrial production beat expectations on a monthly basis, offering the dollar support.
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.