GBP/USD: Pound Advances Despite Strong US Inflation

Strong US inflation data lifted the dollar, pulling the pound off its high for the day on Thursday. The pound US dollar exchange rate rallied to a high of US$1.2571 early in the session. The pair gave up some of those gains later closing at US$1.2548, 0.2% higher. The pound is advancing again versus the dollar in early trade on Friday.

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.

The pound’s gains in the previous session came despite warnings from the Bank of England (BoE) Governor Mark Carney. He warned of the damage that a no deal Brexit could do to the UK economy. Mr Carney said that UK businesses were expecting sales and employment to decline, costs to go up and the economy to slow in the event of a disorderly Brexit. The only positive appeared to be that Mr Carney said that UK banks were stable enough to continue lending in the scenario of a no deal Brexit. This offered some relief to pound traders, helping to lift sterling.

Why is a “soft” Brexit better for sterling than a “hard” Brexit?
A soft Brexit implies anything less than UK’s complete withdrawal from the EU. For example, it could mean the UK retains some form of membership to the European Union single market in exchange for some free movement of people, i.e. immigration. This is considered more positive than a “hard” Brexit, which is a full severance from the EU. The reason “soft” is considered more pound-friendly is because the economic impact would be lower. If there is less negative impact on the economy, foreign investors will continue to invest in the UK. As investment requires local currency, this increased demand for the pound then boosts its value.

Today there is no high impacting UK economic data for pound traders to focus on. They could instead look towards a speech by BoE policymaker Vlieghe. This could offer further clues as to the direction of monetary policy in the UK.

US Inflation Helps Dollar Off Lows

The dollar picked up on Thursday following better than forecast US inflation figures. The dollar had been languishing after Federal Chair Jay Powell as good as confirmed an interest rate rise in July when he appeared before Congress. The prospect of one if not two rate cuts before the end of the year sent the dollar lower. Jay Powell blamed the risk of rising uncertainties in foreign economies and Brexit potentially hitting the US economy.

Investors had been doubtful over whether the Fed would move to cut rates given the strength of the US labour market. Yesterday strong US inflation figures raised those doubts once again. US core inflation, which discounts more volatile items such as food and fuel, unexpectedly ticked higher, pushing above the Fed’s 2% target. The price gauge experienced its biggest gain in nearly two and a half years.

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.

Today the US economic calendar is light. This will leave US investors pondering over whether the latest US inflation figures were sufficiently strong enough to stop the Fed cutting in July. Given that the dollar failed to move into positive territory the broad expectation in the market is a cut from the Fed when it meets at the end of the month.

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