The pound dropped heavily versus the US dollar on Monday, as investors remained sanguine over President Trump’s performance at the G7 Summit at the weekend and instead focused on the disappointing data from the U.K. The pound US dollar exchange rate dropped from an early high of US$1.3490 to a day’s low of $1.33.
|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 dropped sharply at the start of trade on Monday after lacklustre U.K. economic data. Manufacturing output unexpectedly dropped the most in 5 years in April as demand for steel and electrical machinery dropped. Analysts had predicted that manufacturing output would increase by 0.3%, instead it declined by 1.4% in April raising fears once again over the health of the UK economy.
|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.
Today is set to be a busy day for the pound with high impacting economic data in the form of jobs data in addition to a key Brexit Bill vote in the commons.
Analysts are predicting that the UK unemployment rate will remain constant at 4.2%. Analysts are expecting average earnings growth to remain constant at 2.9% in the three months to April. Should this be the case then wage growth would still be comfortably outpacing inflation, which was 2.5% in April. This would indicate that the squeeze on the UK consumer continued to ease, which would be a good sign for domestic inflation and therefore for interest rate rise hopes.
|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.
Trump’s performance at the G7 Summit was shocking by all accounts as relations between the US and its closest allies hit a fresh low. However, investors didn’t dwell of the possibility of further trade tariffs and instead focused on the start of the US — North Korean Summit. This historic first meeting between the two leaders aims to end the threat of nuclear war.
The fact that the meeting ha gone ahead and that it signifies an easing of geopolitical tensions has boosted sentiment after the G7 nightmare.
Geopolitics aside, US inflation numbers will also be of interest to market participants today. Analysts expect core CPI, which excludes more volatile items such as food and fuel to tick higher to 2.2% in May. Up from 2.1% in April.
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.