The pound broke a four-day losing streak against the US dollar on Tuesday. Stronger than forecast data from the UK overshadowed encouraging US figures and rising US interest rate expectations. This helped lift the pound US dollar exchange rate to a high of US$1.3980, although the pair remains notably short of the key psychological level of US$1.40.
|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.
Market participants responded well to an improved outlook for the UK economy. The outlook improved following reports that UK government net borrowing dropped to an 11 year low in the financial year running from April 2017 — March 2018. Public sector net borrowing fell by £3.2 billion to £42.6 billion, surpassing analyst and market expectations. Furthermore, tax receipts covered day to day spending for the first time in 16 years, meaning that the £42.6 billion was spent on capital investment. This means that the money was spent on infrastructure such as roads, schools or railways. In other words, it was spent on the type of investment which lifts economic growth over the longer term. This boosted the pound.
|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.|
As trading begins on Wednesday, the pound continues to show strength versus the dollar even though there is no fresh data due for release. Market participants will need to wait until Friday’s GDP data for further clues as to the health of the UK economy.
The dollar was broadly stronger in the previous session, albeit not as strong as the pound. US China trade fears have eased considerably, which is leaving market participants focused on interest rate expectations and economic data.
Investors continued to increase their expectations of higher inflation and a more aggressive path of interest rate rises from the Federal Reserve. This lifted the dollar versus most of its peers.
|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.|
US economic data showed that Americans were of a sunnier disposition following the easing of trade war fears also boosted the US dollar. US consumer confidence rebounded in April back towards its recent 18 year high. This resurgence in confidence suggests that the US economy is likely to stay on a strong footing, as confident consumers are comfortable spending money which supports the economy.
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.