GBP/USD: Dollar Rallies On Reduced Rate Cut Expectations

A combination of strong US data and concerns over the health of the U.K. economy, sent the pound US dollar exchange rate tumbling over 1.3% across the previous week. The rate hit a nadir of US$1.2481 on Friday. This is the lowest level that the pound US dollar exchange rate has traded at since January.

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 USDHere, £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 GBPIn 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.

Concerns over the health of the U.K. economy dominated following a hat-trick of weak pmi figures across the previous week. The UK economy is almost certain to have experienced a contraction in the second quarter and is potentially heading for a recession by the third quarter. A recession is two straight quarters of contraction.

Pressure is mounting on the Bank of England (BoE) to adopt a more dovish monetary policy and consider cutting interest rates in order to support the UK’s slowing economy. The BoE has signalled that it is now more likely to cut interest rates than hike them.

Why do interest rate cuts drag on 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. Lower interest rate environments tend to offer lower yields. So, if the interest rate or at least the interest rate expectation of a country is relatively lower compared to another, then foreign investors look to pull their capital out and invest elsewhere. Large corporations and investors sell out of local currency to invest elsewhere. More local currency is available as the demand of that currency declines, dragging the value lower.

Also hitting demand for the pound, investors are growing increasingly nervous over the prospect of a no deal Brexit. Economists have frequently warned over the damaging impact that a no deal Brexit could have on the UK economy. Both Conservative leadership candidates Boris Johnson and Jeremy Hunt have said that they are willing to let the UK of the EU without a deal if necessary. The results of the Tory leadership battle will be announced late July.

This week investors will continue focusing on the likelihood of the BoE easing monetary policy. UK data, particularly Wednesdays GDP, manufacturing and industrial production, will be in focus.

Dollar Rallies On Reduced Rate Cut Expectations

The dollar rallied on Friday and continues to move higher in early trade on Monday as investors digest the strong US jobs report. The closely watched non-farm payroll smashed expectations. 224,000 jobs were created in June, well ahead of the 164,000 that analysts had forecast.

The strong reading shows that the US economy is holding up much better than what investors thought. As a result, dollar investors have scaled back their expectations of an interest rate cut by the Fed in the July meeting. This has pushed the dollar higher.

How does the non-farm payroll (NFP) affect the US 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 goods 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 up the currency’s worth.

The US economic calendar is fairly quiet at the start of this week. Investors will be looking towards the Federal Reserve Chairman’s appearance and speech on Wednesday for further clues as to the next move by the Fed.

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