GBP/USD: Trade War Tensions and BoE Rate Drives Pound vs. Dollar

The pound edged lower versus the dollar through most of the session on Wednesday, before clawing back the losses later on to finish flat on the day at US$1.1321.

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.

U.K. manufacturing activity slowed by more than analysts had been expecting in July, hitting demand for the pound. U.K. manufacturing activity dropped to 54, down from 54.4 in June and below analysts forecast of 54.2. Strong global growth had boosted manufacturing during 2017 and whilst analysts were expecting trade tensions and an easing of momentum in global growth to have caused the slow down, it was actually a down to a slowing in domestic demand. The weak reading sent the pound lower.

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 investors will be looking towards the highly anticipated Bank of England monetary policy decision. Market participants are placing a 90% probability on the central bank increasing interest rates by 0.25% to 0.75%. This would be the first time in a decade that the interest rate moves above 0.5%.

Given that investors are almost certain that that the hike will happen, they will be looking closely to see whether this is a one off or if there could be more hikes to follow later this year. Should the vote split be close, for example 5 — 4, and the forward guidance sound cautious, the pound could move lower. On the other hand, should the policy makers vote 6 — 3 or better, investors will be more confident that the economy can handle a rate rise and the pound could rally.

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 Surprises From Fed

The Federal Open Market Committee kept monetary policy unchanged as market participants had expected. The Fed upgraded its view of the US economy to “strong” from “solid” at the June meeting. Furthermore, it noted that consumer spending and business investment had grown strongly. The positive tweaks support the idea that the Fed are looking to raise interest rates in September. Investors are pricing in a 92% chance of this happening. The dollar barely moved following the announcement.

Instead the market switched quickly back to trade war tensions after the Trump administration said that it was looking into increasing tariffs to 25% on $200 billion worth of Chinese imports. This is a clear sign that the trade war is escalating, rather than moving towards a conclusion and this is unnerving dollar traders.

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