GBP/USD: The Tale Of Two Central Banks

Swings for the pound US dollar exchange rate were once again dramatic on Wednesday. No deal Brexit planning and a Federal Reserve which was less dovish than market participants had been expecting, sent the pound US dollar on a roller-coaster ride. After hitting a high of US$1.2679, the pound tumbled to close at US$1.2626.

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.

Pound traders were jittery in the previous session as no deal Brexit planning ramped up in both the UK and the UK. This is making a no deal Brexit more of a reality as the crunch vote in Parliament mid-January draws closer.

With little else Brexit wise to digest, traders switched their attention to UK consumer inflation data. Inflation, as analysts had forecast dipped to 2.3% in November, down from 2.4% the previous month. Inflation is at the lowest level in 20 months. Whilst falling inflation means the squeeze on consumers is ending; it also means that the Bank of England are more likely to push back on any interest rate rises.

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.

As the busy week continues for the pound, investors will look firstly towards UK retail sales and then towards the Bank of England monetary policy decision today. Analysts are not expecting the central bank to hike rates. The last rate hike was in August to 0.75%. Brexit uncertainty lingering on the horizon is expected to keep the brakes on the central bank, even though wages grew at 3.3% and unemployment remains historically low.

Fed Less Soothing Than Investors Expected

The dollar dipped across the day on Wednesday before rallying higher following the Federal Reserve’s policy announcement. As forecast the Fed hiked interest rates by 25 basis points in a unanimous decision. However, the Fed were not as cautious on their outlook as investors had been expecting. The Fed gave a strong assessment of the economy and indicated two hikes were planned for next year. This was down from three.

However, investors were expecting a more calming tone from the Fed Chair Powell. The fact that he didn’t drop the phrase about further gradual increases, but just tweaked it, plus the fact that the Fed will continue reducing the size of the Fed’s balance sheet (another tightening mechanism) shows that Jeremy Powell is still on a relatively aggressive path.

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