GBP/USD: Will UK Service Sector Data Lift Pound vs. Dollar?

The pound gave up its early rally on Wednesday as investors looked past impressive UK construction data and focused on the US Federal Reserve monetary policy statement. The pound US dollar exchange rate hit a high of US$1.3666 before falling lower.

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.

After weeks of data which came in worse than analysts were expecting, pound traders finally received some good news on Wednesday. Activity in the UK construction sector rebounded in April after dropping sharply in March. The construction pmi increased to 52.5, up from 47 in March and ahead of the 50.5 that analysts pencilled in. Although the construction sector does not make up a huge part of the UK economy, given the decline in the sector had been so pronounced over the past few months, it had impacted on economic growth. Therefore, investors cheered the strong rebound.

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.

Today market participants will focus on the service sector pmi. The service sector also declined in March and investors and analysts alike are expecting a rebound. The service sector is the most dominant sector in the UK economy, therefore a strong rebound could help boost hopes of strong economic growth going forward. Even if the service sector does rebound by more than analysts are expecting, it will probably be a case of too little too late for the Bank of England who are now unlikely to raise interest rates when they meet this month. Just a few weeks ago investors had assumed that the central bank would increase rates. After weeks of weak data optimism for a hike has disappeared.

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.

No hike but a more hawkish Fed

The dollar has been trading at its highest levels since the beginning of the years as investors expected a more aggressive Fed. With inflation in the US moving higher and almost at the Fed’s 2% target, and unemployment ticking lower investors have been expecting the US Federal Reserve to raise interest rates at a more aggressive pace during the course of the remainder of the year. The Fed, however, left U.S. interest rates unchanged, but it took note of rising prices. This hawkish tone suggests that Fed will raise it in 2018 instead of three as previously planned. As a result, the dollar has continued to hold ground to some extent, versus the pound.

Today investors will return their attention to the US service sector data. Analysts are expecting activity in the sector to remain elevated, although slightly lower than in March. A strong reading will help keep the dollar elevated.

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