GBP/USD Climbing as Federal Reserve's Lack of Consensus Weighs on Dollar

06.07.17
4 minute read
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The pound was climbing higher against the U.S. dollar as investors digested the June minutes of the Federal Reserve monetary policy meeting and several days of poor data from the UK. The GBP-USD exchange rate pulled back from a high of $1.3030 on Monday to a low of $1.2923 on Wednesday, before recovering some ground to $1.2930 as Wednesday drew to a close.

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 U.S. 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 U.S. dollar’s worth versus the British pound. If the sterling number gets larger, it’s good news for the dollar.

Although the pound has recouped some losses against the dollar, that appears to be due to a weak dollar rather than being attributed to a strong pound. Economic data throughout this week has painted a grim outlook for the UK economy as the summer approaches.

The UK’s manufacturing and construction PMI’s both printed lower than what analysts had been anticipating. This indicates a fall in business confidence amid recent political uncertainty following the general election, and amid growing concerns over the uncertainty stemming from Brexit.

Data on Wednesday showed that the activity of the dominant UK service sector also fell short of what analysts had forecast. This confirms that the squeeze on pay, as wages fail to keep pace with the rising cost of living, is negatively affecting both the service sector and the UK economy.

Why does poor economic data drag on a country’s currency?
Slowing economic indicators point to a slowing economy. Weak economies have weaker currencies because institutions look to reduce investments in countries where growth prospects are low and then transfer money to countries with higher growth prospects. These institutions sell out of their investment and the local currency, thus increasing supply of the currency and pushing down the money’s worth. So, when a country or region has poor economic news, the value of the currency tends to fall.

Tomorrow is a quiet day on the economic calendar for the pound, with the trade balance unlikely to impact greatly.

Fed minutes show split outlook

The minutes from the Federal Open Market Committee meeting in June were released in the previous session and did little to soothe investor nerves. There was a lack of consensus among policy makers as to the next move by the central bank. The minutes showed that policy makers vaguely indicated an intention to raise rates before the end of the year; however, some members of the FOMC expressed concerns over the recent drop in inflation. Inflation is expected to be closely watched by the Fed before any further action.

When inflationary pressure is low central banks will not usually look to raise interest rates, so a declining rate of inflation pushes interest rate expectations lower. The falling interest rate expectation weighed on the value of the dollar.

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.
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