The pound advanced versus the US dollar on Tuesday thanks to an improved market mood. The pound US dollar exchange rate closed at US$1.25. The pair is edging lower in early trade on Wednesday.
|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.
The pound charged higher in the previous session, despite British Prime Minister Boris Johnson confirming that he still intends to take the UK out of the EU by 31st October. By law, Boris Johnson must request an extension to Article 50 if a Brexit deal hasn’t been approved by Parliament by 19th October. However, British media reports suggest that the PM’s team are looking at ways of circumventing the new law. This means that a no deal Brexit remains a very real possibility.
Today pound investors will continue watching developments at the UK Supreme court over whether Boris Johnson acted illegally suspending Parliament for such an extended period of time just prior to Brexit. Reports indicate that Boris Johnson is on the backfoot after the first day of the hearing, giving him less room to manoeuvre over Brexit.
UK inflation data will also be under the spotlight today. Analysts are predicting that inflation increased 0.4% month on month in August. However, they also forecast that it ticked lower to 1.8% year on year, down from 1.9%. Inflation falling away from the central bank’s 2% target will do little to encourage the central bank to hike rates and could keep pressure on the pound.
All eyes on FOMC
The dollar declined in the previous session despite encouraging data from the US manufacturing sector. US manufacturing and industrial production increased ahead of analyst’s expectations in August. The dollar declined after the Federal Reserve injected liquidity into the financial system. The central bank pumped in $75 billion in an attempt to ease a dislocation between overnight funding and overnight funding needs of the banks. The act of injecting cash into the system devalued the dollar.
The move by the Fed comes ahead of the Federal Reserve monetary policy announcement today. This will be the most closely watched event of the week. Market participants broadly expect the Fed to cut interest rates for a second time this year. Investors will also be watching for clues as to whether the Fed intends to continue cutting rates across the rest of the year.
|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.|