GBP/USD: Dollar Spikes vs Pound As Fed Raises Rates

Despite a more aggressive Federal Reserve and some uninspiring economic data from the UK, the pound US dollar exchange rate managed to end the day marginally higher. There was significant volatility across the session on Wednesday with the rate hitting a low of US$1.3310 before climbing to a high of US$1.3390.

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.

UK inflation printed at 2.4% in May. Some market participants had been optimistic that the recent rally in oil prices may have lifted inflation through higher prices at the pumps, however that wasn’t the case. The uninspiring data comes following disappointment earlier in the week when UK manufacturing output slumped to a 5-year low and wage growth unexpectedly slipped lower. Altogether this paints a worrying picture for the health of the UK economy and makes a rate rise in August by the Bank of England (BoE) look increasingly unlikely. As the prospects of a rate rise declined so did the value of the pound

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.

UK retail sales data could create some volatility for the pound today. Analysts are expecting retail sales to have increased by 2.5% year on year in May, up from 1.5% in April. Retail sales are an indication of future inflation. Strong retail sales suggest inflation could pick up down the road. Higher inflation means a future interest rate rise is more likely. Therefore, a strong reading tomorrow could lift the pound.

Fed Expects 4 Hikes Through The Year

Another interest rate rise of 0.25% by the Federal Reserve on Wednesday saw the dollar spike higher before it returned to its pre-Fed price. The rate hike had been widely anticipated by market participants. The Fed were also upbeat on the outlook of the US economy. They expect unemployment to continue falling, potentially to 3.5% and they expect their preferred measure of inflation the PCE tick higher towards the 2% target. At the previous meeting the Fed has forecast 3 hikes across this year, this has now been increased to 4. The only slight concern was that of trade wars, which the Fed said was currently being overshadowed by Trump’s tax gains.

Trade wars are once again in the spotlight as Trump expected to slap levies on $50 billion worth of Chinese imports from tomorrow. The dollar is heading lower.

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