GBP/AUD Pound Rallies Higher as BoE a Step Closer to Raising Interest Rates

16.06.17
4 minute read
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The pound Australian dollar exchange rate was charging higher for the pound after a volatile session. The previous session saw the pound sink to a day’s low of A$1.6686 before strengthening to a high of A$1.6872.

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 = 1.72119 AUD

Here, £1 is equivalent to approximately A$1.72. This specifically measures the pound’s worth against the Australian dollar. If the Aussie dollar amount increases in this pairing, it’s positive for the pound.

Or, if you were looking at it the other way around: 1 AUD = 0.57677 GBP

In this example, A$1 is equivalent to approximately £0.58. This measures the Australian dollar’s worth versus the British pound. If the sterling number gets larger, it’s good news for the Aussie dollar.

Sterling strengthened following the shock announcement by the Bank of England’s (BoE) Monetary Policy Committee (MPC) that 3 of its 8 members had voted for an interest rate increase. The vote split of 5-3 was much closer than the 7-1 split that analysts had been expecting. Five members of the committee voted to keep interest rates at the current historically low level of 0.25%.

Why does the closeness of the split in the MPC matter? The more members that vote for a rate rise, the sooner the rate rise is expected. When interest rate expectations move higher, the value of the currency often moves higher too. This is why the pound rallied.

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.

The minutes released from the meeting showed that the majority of committee members feared that hiking interest rates would crush UK’s economic growth and, thus, allowing inflation to climb higher was the preferable option. When you take inflation into account - which is nearly at 3%, - UK wages are declining. With retail sales growth also slowing, BoE is running short of options.

Australian employment figures smash forecast

Demand for the Australian dollar has also been strong, albeit weaker than the pound. High impacting Australian economic data had been in short supply in the first part of this week, but the newly released Australian employment figures changed that. Australia added 42,000 jobs in May, smashing analysts’ expectations of only 10,000. The unemployment rate also fell sharply from 5.7% to 5.5%, dispelling concerns of an economic slowdown in Australia.

The Australian economy is showing signs of strength as jobs data, business surveys and forward-pointing indicators are seem encouraging. A sticky point is the first quarter GDP, which grew at its slowest rate year on year since 2009. However, the Reserve Bank of Australia has essentially said that it’s willing to look past the first quarter slowdown, which it believes was impacted by a major storm in Queensland earlier in the year.

The strong jobs data that came out has now increased interest rate expectations for Australian. This, in turn, boosted the value of the Australian dollar.

How does strong jobs data boost the currency?
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.
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