GBP/USD: Will US Consumer Inflation Hit The Fed's 2% Target?

11.04.18
3 minute read
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Comments from a Bank of England policy maker sent the pound higher versus the dollar on Tuesday. The pound US dollar exchange rate hit a two week high of US$1.4188.

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 received a boost after BoE monetary policy maker Ian McCafferty said that the central bank should not dally over modestly raising interest rates. Despite Ian McCafferty being a known hawk on the BoE monetary policy committee, his comments still lifted the pound as investors believe that a May rate hike could still be on the table. Ian McCafferty voted to raise rates at the last central bank meeting, investors still don’t know how other BoE policy makers will vote in May but that didn’t stop the pound from benefitting from McCafferty’s more aggressive stance.

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 UK economic calendar has been very light so far this week. However, that is set to change today with significant releases including manufacturing and industrial production output for March and construction output for February. Analysts are expecting a solid uplift in the figures for February, except for construction which analysts predict will have fallen.

Inflation Ticking Higher Gives Dollar A Late Boost

Better than forecast economic data boosted the dollar later on in the previous session. Demand for the dollar picked up after wholesale inflation, as measured by the producer price index, ticked higher in March. This tends to point to a pick up in consumer level inflation down the line. As inflation picks up, interest rate hikes are more likely which boosts the currency.

Today investors will focus on inflation data for the US, as measured by the consumer price index. Low inflation has been a challenge for the Fed for much of 2017, however inflation could finally be on track to reach the Fed’s 25 target. Analysts are expecting inflation to have increased from 2.2% year on year in March to 2.4%. Meanwhile core inflation, which excludes more volatile items such as food and fuel is expected to have increased from 1.8% to 2.1% in March, above the all important 2% target. Higher inflation will boost hopes of a more aggressive hiking path from the Federal Reserve. Market participants remain divided as to whether the Fed will raise rates 2 or 3 more times this year. A strong inflation figure could lift the pound as more investors bet on 3 more rate rises.

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