The pound plummeted against the dollar on Tuesday. Weaker than forecasted UK data and better than expected US data pushed the pound lower, whilst simultaneously boosting the dollar. The pound fell from a high of around US $1.2970 to a session low of US$1.2847.
Demand for the pound tumbled as investors digested the most recent inflation data from the Office of National Statistics. The data showed that the cost of living in Britain remained steady at 2.6%, falling short of analysts’ expectations of 2.7%. Although inflation is still above the BoE’s target rate of 2%, it is at last showing signs of easing. This is removing pressure from the central bank to raise interest rates as a mechanism of dealing with high inflation. The BoE have previously said that they're willing to look through the high inflation, as policymakers believe it’s temporary. In short, today’s inflation data dampened interest rate expectations, which pulled sterling lower.
|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 the focus switches towards jobs data, such as the unemployment rate and average wage growth. Analysts anticipate that the unemployment rate will remain at decade lows of 4.5%. Analysts are forecasting wages to have grown by 1.8%, which is 0.8% lower than inflation. This means wages continue to fall once inflation is accounted for, highlighting the struggle facing households.
Meanwhile the mood for the dollar picked up sharply as US retail sales surged last month. Retail sales grew 0.6% in July, up from a -0.3% contraction in the previous month. Not only did these figures easily beat expectations, but also they add to evidence that the US economy has had a solid start to the third quarter.
Retail sales figures earlier in the year had been lacklustre and had contributed to the belief that the US economy was not ready for another interest rate rise. However, investors believe that today’s numbers, in conjunction with strong labour data earlier in the month will increase the chances of another Federal Reserve interest rate hike before the end of the year, which has boosted the dollar.
Looking ahead, the details from the Federal Open Monetary Committee (FOMC) are due to be released later today. Investors will be paying particular attention to any clues as to when the Fed could start to reduce its balance sheet or tighten monetary policy.
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