Unexpectedly weak economic growth in Britain in the first quarter of the year sent the pound tumbling hard versus on the US dollar on Friday. Sterling plummeted 1% versus the dollar, hitting a low of US$1.3748. This is the weakest that the pound has traded versus the dollar in 8 weeks.
|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.
Demand for the pound has been soft recently as investors digested a slew of weaker than forecast economic data. Earlier in the month market participants learnt that wages grew by less than what analysts were anticipating. This was followed by news of a lower rate of inflation and then soft retail sales. This was capped off on Friday by data showing that the U.K. economy almost stalled to a halt with quarter on quarter growth at just 0.1%.
The U.K. economy growing at the slowest pace in 5 years has contributed to a reduced probability of the Bank of England (BoE) raising interest rates in May. There is a good chance that the BoE will consider the economy and the consumer to be too weak to sustain an interest rate rise at the moment. August is now looking more likely as the month for a potential interest rate rise.
|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.|
Looking across this week, the U.K. trading calendar is sparse, with the purchasing managers index prints as the principal possible causes of volatility. These figures should give a clearer picture as to the strength of the U.K. economy.
|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.|
Demand for the dollar is the strongest that it has been in 3 months. The dollar has been boosted recently by investors betting on a more aggressive Federal Reserve. In other words, market participants are thinking that the central bank will increase interest rate more quickly than initially thought.
The dollar was also lifted further by better than expected Gross Domestic Product (GDP) data at the end of last week. The US economy grew at 2.3%year on year, faster than the 2% forecast. The strong economy would make it easier for the Fed to hike, knowing that the economy could sustain higher interest rates.
This week is a busy week for dollar traders. Firstly, the Fed is expected to hike rates and secondly investors will look to the US non-farm payroll on Friday, where US unemployment is expected to hit 2%, the lowest in two decades.
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.