Dollar Lowers Versus the Pound Amidst US Inflation Concerns

TransferWise content team
4 minute read

The dollar weakened in trading on Thursday after US inflation concerns returned to haunt the market. Consequently, the pound US dollar exchange rate charged higher, returning back to $1.3530, a level where it has been comfortably trading since the beginning of the new year.

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 has had a fairly uninspiring week. Despite a barrage of economic data earlier in the week, which would have normally impressed pound traders, the currency barely flinched. This included news that UK manufacturing sector activity was at a 10-year high and that the NIESR increased it GDP estimate for the 4th quarter to 0.6%, up from 0.5%.

Pound traders remain nervous about the health of the UK economy and concerned over the perceived weakness of UK Prime Minister Theresa May at a crucial point in Brexit. These concerns combined, are keeping investors away from sterling.

How does political stability boost a currency?
Political stability boosts both consumer and business confidence, which means corporations and regular households alike are more likely to spend money. The increased spending, in turn, then boosts the economy. Foreign investors prefer to invest their money in politically stable countries as well as those with strong economies. For foreign investors to put their money into an economy, they need local currency. As they acquire the money needed, the demand for that particular currency increases, which then boosts its value.

Today there is no high impacting UK economic data on the calendar. Instead investors will look towards next Tuesday when UK inflation figures are likely to drive volatility.

US Consumer Inflation Index (CPI) In Focus

After a weak start to the new year, the mood for the dollar had picked up this week. However, Thursday’s release of the producer price index (ppi) brought the dollar back down. The producer price index measures inflation at a wholesale or factory gate level. A higher ppi figure would indicate that inflation at consumer level could pick up in the near future.

The US PPI reading fell for the first time in 1 ½ years in December, rising 2.6%, down from 3.1% in November. The fall weighed on investor expectations for Fed action this year. The Federal Reserve are anticipating that they will raise interest rates three times this year. However, Fed officials have been growing increasingly concerned over the sluggish nature of US inflation. Should inflation fail to pick up, the Fed may struggle to raise rates as often as it hopes.

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 US consumer inflation (CPI) data. Analysts are expecting the headline CPI figure to have ticked down from 2.2% in November, to 2.1% in December. Analyst are anticipating that core CPI, which removes more volatile items such as food and fuel will remain steady at 1.7%. This is still some way off from the Fed’s 2% inflation target. A lower than forecast reading could see the dollar drop further.

This publication is provided for general information purposes only and is not intended to cover every aspect of the topics which it deals. It is not intended to amount to advice on which you should rely. You must obtain professional or specialist advice before taking, or refraining from, any action on the basis of the content in this publication. The information in this publication does not constitute legal, tax or other professional advice from TransferWise Limited or its affiliates. Prior results do not guarantee a similar outcome. We make no representations, warranties or guarantees, whether express or implied, that the content is the publication is accurate, complete or up to date.

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