Another piece of disappointing UK economic data helped send the pound lower against the dollar. The pound has tumbled 1.5% versus the dollar so far this week, extending losses of 1.6% in the previous week and a further 1.6% the week before that. The pound US dollar exchange rate hit a fresh four month low at US$1.3538, before rebounding slightly towards the end of the 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 focus for pound traders this week has been firmly on economic data, more specifically the purchasing managers index (pmi’s). After the manufacturing sector showed a slow down in activity, the construction sector rebounded strongly after a particularly weak March. Investors and analysts were optimistic of a strong rebound in the service sector as well. Service sector activity picked up from Match’s 51.7 to 52.8. However, it was still short of the 53.5 expected by analysts. Given the dominance of the service sector in the UK economy a slightly disappointing figure had a strong impact on the pound.
|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.
Data from the UK economy has been much weaker than analysts had been expecting throughout April, pointing to a struggling economy. One month ago, market participants were confident that the Bank of England (BoE) was going to hike rates when it meets next week. This now looks highly improbable. Even so, investors will still watch the BoE report carefully for any clues as to the expected direction of the economy from here.
|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.
The US dollar was out of favour on Thursday, albeit slightly less so than the pound. The dollar rallied for its 7th consecutive session versus the pound, despite weaker than forecast growth in the US non-manufacturing sector. The US ISM non-manufacturing figure hit 56.8 in April against 58.2 analysts had pencilled in. Recent international trade tensions were cited as a principal cause of nervousness among business, causing the index to slip. The weaker number weighed on demand for the dollar.
Today the US jobs report will be evaluated for investors to assess the strength of the US labour market and inflationary pressures. Analysts are expecting the number of jobs created to rebound in April to 193,000, up from the unexpectedly sharp drop to 103,000 in March. Meanwhile average earnings growth is expected to remain constant at 2.7%. Strong figures than those anticipated by analysts could lift the dollar 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.