GBP/USD: UK and US Manufacturing in Focus As Investors Brace For A Busy Week

02.01.18
4 minute read
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As trading kicked off 2018 the pound was making the most of the weaker dollar. The pound US dollar exchange rate started the new year above the key psychological level of US$1.35.

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 US dollar exchange rate powered higher across 2017, gaining close to 10%. That is an impressive rise for sterling, given the politically turbulent year the UK has experienced. However, the outlook for 2018 remains unsettled. Analysts are expecting Brexit uncertainties to weigh on the economy in 2018, with economic growth predicted to be 1.5% at best and business investment is expected to grind almost to a halt. Neither prediction is good for the UK economy, which could prevent sterling from rising much higher until there is more certainty over Brexit.

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.

After a quiet last week, between Christmas and new year, investors will be pleased to know that here are a few more potentially interesting economic data points this week for the pound. These start to day with manufacturing purchasing manager’s index (pmi). This is a forward-looking indicator which gives an idea as to the health of the manufacturing sector. Last month, the Manufacturing pmi for November recorded a 4-year high, as manufacturing picked up a gear. Analysts are forecasting that the figure with just ease back slightly in December from 58.2 to 58. A figure lower than analysts’ expectations could see the pound weaken slightly.

Dollar weak as it enters the new year

The dollar suffered its worst year in over a decade in 2017, not just against the pound, but against its peers as whole. This is perhaps a little surprising given that the Federal Reserve raised rates 3 times in the past year, making it the most aggressive central bank. Added to that, the low US unemployment and the strong economic growth and the dollar definitely appears to have fallen short of where analysts might have expected it to finish the year.

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.

Today sees the release of the US manufacturing pmi, which could create some volatility. Looking ahead, this week provide several high impacting data points such as Federal Reserve minutes report and the US jobs report at the end of the week.

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