Pound Boosted by UK Budget While Dollar Suffers on Fed Inflation Fears

23.11.17
4 minute read
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The pound charged higher versus the dollar in the previous session. UK Chancellor Philip Hammond successfully diverted attention away from weak UK growth forecasts with his budget announcement. Meanwhile, in the US, investors focused on US Fed concerns over inflation in an otherwise positive US policy meeting in November. The pound surged northwards as a result of US concerns, hitting a high of US$1.3325 for the pound.

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 worst part of the UK Budget was dealt with quickly at the beginning of the UK Chancellor’s speech. The Office for Budget Responsibility (OBR) slashed UK 2017 growth forecasts from the 2% predicted in March to just 1.5%. Meanwhile, 2018 economic growth was revised down to 1.4% from 1.6% and the OBR predicted growth of just 1.3% in 2019 and 2020. The weak figures sent the pound sharply lower.

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.

Despite poor news, Chancellor Hammond was quick to move to an upbeat tone, pleasing pound investors with his spending revelations. Of particular interest to pound traders was the Chancellor’s pledge to put aside a further £3 billion for Brexit preparations. This extra funding is set aside to help the government prepare for every possible outcome from Brexit, including a cliff edge or hard Brexit. The news was well received by the hard line Brexiters in the UK Conservative party and may help to stabilize in-fighting within the party.

Today, investors will switch attention back towards UK economic data. Analysts are forecasting that UK third quarter economic growth will be 1.5% year on year, or 0.3% quarter on quarter. Should the data surprise on the upside, the pound could rally higher.

US Fed Concerns Over Dollar Inflation Sends Pound Higher

The dollar continued to weaken after the release of the US Federal Reserve minutes from the November monetary policy meeting. The minutes from the meeting, where interest rates were kept on hold, confirmed to a degree what investors already knew.

The US policymakers generally agreed that the American economy was poised for strong growth; they remained happy with the progress of the US labour market. Several Fed members also said that they were increasingly confident that the US Congress would pass the proposed tax cuts, which should boost business investment.

However, the Fed remained stumped over the low levels of inflation. US inflation refuses to significantly pick up, despite low levels of unemployment which support consumer spending. In conclusion, dollar investors are confident that a rate hike is coming in December. However, after December, there’s nothing assured. As a result, the growing uncertainty of the possibility of US rate hikes next year kept the dollar out of favour.

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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