The pound climbed against the US dollar on Wednesday thanks to surprisingly strong UK jobs data. Meanwhile President Trump and a more conservative US Federal Reserve weighed on sentiment for the dollar. Heading into Thursday the pound US dollar exchange rate is trading around US$1.29, levels not seen since early July.
The jobs market in the UK is tightening. Unemployment unexpectedly fell in July to 4.4%, its lowest level since 1975. As unemployment fell, average earnings jumped unexpectedly to 2.1% in June, considerably above the 1.9% that had been pencilled in by analysts. This shows that the gap between inflation, which was 2.6% in June and wages is finally showing signs of closing.
The data boosted the pound because of the expected implication on the Bank of England (BoE) interest rate policy. So far, weak wage growth has been one of the main reasons that the BoE has shied away from hiking rates. However, yesterday’s impressive wage growth should increase inflation going forwards, boosting the possibility of a hike.
|How does strong jobs data boost the currency?|
|It works like this, when there's low unemployment and high job creation, the demand for workers increases. As demand for workers goes up, wages for those workers also go up. Which means the workers are now taking home more money to spend on cars, houses or in the shops. As a result, demand for goods and services also increase, pushing the prices of the good and services higher. That’s also known as inflation. When inflation moves higher, central banks are more likely to raise interest rates, which then pushes the worth of the currency higher.|
Today UK retail sales data will give the markets a clearer insight as to whether households are refraining from spending given the increasing cost of living. Should retail sales value increase less than the 1.2% anticipated by analysts, then the pound could give up recent gains.
The dollar is out of favour. Firstly due to President Trump, who seems to be making the news on a daily basis. The President of the US weighed on sentiment for the dollar after announcing the end of the Manufacturing Council and Strategy and Policy Forum. This is a group of top business leaders who are meant to advise the President. The group claim they resigned following Trump’s poor response to the domestic events at the weekend, which saw one women die and 19 people injured by white nationalists. Trump, claims he ended it by Twitter.
Secondly, the US Federal Reserve minutes portrayed an increasingly more conservative central bank. Policymakers are concerned about the stubbornly slow pace of inflation, with many envisaging inflation to stay below the bank’s 2% target level for much longer than expected. The central bank has said on previous occasions that it would want to see inflation tick higher before increasing interest rate. As a result, the details served to dash interest rate hike hopes, which kept the mood for the dollar soft.
|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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