Another UK disappointing macroeconomic figure sent the pound tumbling lower versus the US dollar on Tuesday. The pound US dollar exchange rate dipped below US$1.36 for the first time since early January as it finished in negative territory for the fifth straight session.
|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 was firmly out of favour after figures showed that UK manufacturing growth slowed to its slowest in 17 months in April. The manufacturing purchasing managers index declined by more than what analysts had anticipated, dropping to 53.9 from 55.1 in March and short of the 54.8 analysts estimated. Whilst softer figures in February and March had been blamed on poor weather conditions, the same excuse can’t be used in April.
|Why does poor economic data drag on a country’s currency?|
|Slowing economic indicators point to a slowing economy. Weak economies have weaker currencies because institutions look to reduce investments in countries where growth prospects are low and then transfer money to countries with higher growth prospects. These institutions sell out of their investment and the local currency, thus increasing supply of the currency and pushing down the money’s worth. So, when a country or region has poor economic news, the value of the currency tends to fall.|
Just three weeks ago investors had been expecting the Bank of England (BoE) to hike interest rates when they meet this month. However, after a string of worse than anticipated figures from the UK economy, an interest rate rise this month now looks highly improbable. Even solid readings from construction pmi and service pmi over the coming days is unlikely to change policy makers minds.
Today investors will look towards the construction pmi. Analyst are expecting construction sector activity to have rebounded in April after contracting in March. Should the rebound fail to materialise, the pound could sink lower still.
Dollar Rallies Ahead of Fed Rate Decision
The dollar continued to bound higher across the board in the previous session, reaching multi month highs versus all its major peers. The dollar rallied despite US economic data falling short of analysts’ expectations. Manufacturing activity in the US slowed to 57.3, well below the March reading of 59.3, whilst also falling short of analysts’ expectations. Usually a reading printing so far below analysts’ estimates would cause a a big sell off. However, market participants are so sure that the Federal Reserve will hike interest rates in May, regardless of the softer reading, therefore the dollar has remained strong anyway.
|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.|
Investors will now look ahead to today’s Federal Reserve policy meeting. Whilst a rate rise is almost a certainty, market participants will be watching closely for clues as to the path of hikes going forward. A more aggressive sounding Fed could send the dollar further northwards.
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.