A much stronger than forecast US jobs report caught the market off guard on Friday and the dollar surged against its peers including sterling. The stronger dollar sent the pound US dollar exchange rate plummeting over 100 points or 0.7% on Friday to a low of US$1.3024. This is the lowest level that the pound US dollar exchange rate has traded at for over a week and a half.
Demand for the pound has been subdued since the Bank of England (BoE) monetary policy decision and quarterly inflation report were released last Thursday. The central bank downgraded its growth outlook and squashed hopes of an interest rate rise in the near future, which weighed on sterling
|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.|
Whilst last week was the first week of the new month, which sees lots of fresh data released, the second week of a new month tends to be quieter as far as macroeconomic data releases are concerned. The main focus for the pound is not until Thursday, when the latest industrial production and manufacturing figures come out.
The headline figure for the US non-farm payroll report was 209,000 jobs created in July, against analysts’ forecast of 180,000. Added to this, June’s number was revised higher, bringing the averages for the last three months to an impressive 195,000 jobs created per month. The unemployment rate unexpectedly dropped to a 16 year low, whilst wages increased at the anticipated rate of 0.3% for the month.
The dollar surged as investors interpreted the data as increasing the odds of an interest rate rise by the Federal Reserve.
|How does the non-farm payroll (NFP) affect the U.S. dollar?|
|It works like this, when there is low unemployment and high job creation, the demand for workers increases. As demand for workers goes up, wages for those workers also go up. Which means the workers are now taking home more money to spend on cars, houses or in the shops. As a result, demand for goods and services also increase, pushing the prices of the good and services higher. That’s also known as inflation. When inflation moves higher, central banks are more likely to raise interest rates, which then pushes the worth of the currency higher.|
However it is important to remember that one-month of strong data doesn’t constitute a trend. Dollar investors are likely to want to see more evidence that the US economy is on a path of solid growth and inflation increasing before the dollar makes a meaningful comeback.
This week is quiet as far as influential US economic data is concerned. Investors will look towards Friday when key US inflation data may help provide further direction for the dollar.
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.