The pound fell sharply lower versus the dollar in early trade on Monday as investors reacted to the resignation of UK Home Secretary. The pound US dollar exchange rate hit a low of US$ 1.3713, before rebounding later in the day.
|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 sold off heavily last week on further signs of a stalling UK economy, which killed off any remaining optimism of a Bank of England (BoE) interest rate rise in May. Sterling was then sent lower early on Monday as investors digested news that Amber Rudd, UK Home Secretary resigned after mounting pressure over her handling of the Windrush scandal. She is the fourth cabinet minister to resign in just six months. This level of political instability weighed on demand for the pound.
Today investors will switch attention back towards economic data with UK manufacturing and construction pmi’s in focus over the next day or two. Analysts are expecting construction pmi to have expand again in April are falling sharply into contraction in March. Construction pmi dropped to 47 in March and is expected to rebound to 50.9 in April, whereby 50 separates contraction from expansion.
The construction pmi will be of particular interest given that is was highlighted as a principal contributing factor to the UK economy almost stalling in the first quarter of the year. An increase in construction activity could help boost sentiment towards sterling.
|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.|
The dollar had traded higher in early trade yesterday; however, following the Personal Consumption Expenditure (PCE) release, the Fed’s preferred measure of inflation, the dollar dropped. Inflation reached 1.9% in April, close to the Fed’s 2% inflation target and experienced its biggest jump since January 2017. Usually a solid inflation reading would send the dollar higher as it would increase the probability of an interest rate rise at the next Federal Reserve meeting.
However, market participants are counting on a 93% probability that the Fed will hike rates when they meet on Thursday. As a result, this data had little impact on investors, who were already almost completely certain of a 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.|
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.