Weaker than expected eurozone inflation and a hawkish cut from the Federal Reserve sent the euro US dollar exchange rate lower on Wednesday. The pair closed 0.4% lower at US$1.1029. The dollar is paring gains in early trade on Thursday.
| 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 EUR = 1.12829 USD Here, €1 is equivalent to approximately $1.13. This specifically measures the euro’s worth against the dollar. If the U.S. dollar amount increases in this pairing, it’s positive for the euro. Or, if you were looking at it the other way around: 1 USD = 0.88789 EUR In this example, $1 is equivalent to approximately €0.89. This measures the U.S. dollar’s worth versus the euro. If the euro number gets larger, it’s good news for the dollar. |
The euro was subdued in the previous session following the release of lacklustre inflation figures for the bloc. Inflation in the eurozone increased 0.1% month on month in August. This was below the 0.2% growth that analysts had pencilled in. On an annual basis, inflation remained steady at an almost three-year low of 1%.
Lacklustre inflation has been a headache for the ECB for some months now. The data is supportive of Mario Draghi’s pledge of indefinite monetary stimulus to support the ailing economy and boost inflation.
Today there is no eurozone economic data to be released. Investors will look ahead to Friday’s consumer confidence. A further deterioration in confidence could drag on the euro.
Fed Cuts Rates By 0.25%
The dollar was in favour in the previous session despite the Federal Reserve cutting interest rates. As market participants broadly expected, the Federal Reserve cut interest rates by 0.25%. However, the central bank did not signal any further cuts in 2020, despite severe pressure from President Trump to slash rates and amid ongoing trade uncertainty with China.
Investors had been expecting the Federal Reserve to sound more cautious over its outlook of the US economy. Instead the more hawkish sounding Fed meant that investors had to reassess the probability of further rate cuts this year, causing the dollar to rise.
| 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. |
Interestingly, in the Fed there was a mix of opinions in the FOMC over changing economic conditions. In total there were three dissenters. One, believed that the Fed should make a deeper cut by 0.5%. Two other policy makers believed the Fed should do nothing.
Today dollar investors will continue to digest the Fed’s actions and comments. Additionally, investors could cast an eye towards US jobless claims figures and US home starts. Stronger data could boost the dollar higher.
