Fed Official's Comments Pulls Dollar Lower Versus Pound

18.08.17
3 minute read
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This week the pound has tumbled to its worst levels against the US dollar for over a month. Despite some encouraging UK data and reduced expectations of a Federal Reserve interest rate rise, sterling has been unable to achieve a meaningful recovery. The pound US dollar is currently trading at $1.2887, some 2.8% lower than its recent high on 3rd August.

This week has been a busy week for high impacting economic releases for the pound. Data early on showed that inflation in the UK held steady at 2.6%, whilst wage growth ticked higher to 2.1%. Although wages are closing in on inflation they are still failing to keep pace with inflation. This means that the consumer is being squeezed as they face the higher cost of living with effectively less money.

Retail sales figures released yesterday highlighted the squeeze being felt by the consumer. Retail sales in July increased by 0.3%, beating analysts expectations. However the figure also represented a noticeable drop from June’s 0.6% increase. Looking more closely at the numbers, they show that strong food sales were responsible for July’s growth, as all of the other main sectors showed a decrease. Given that retail sales are a key indicator as to the health of the UK economy, investors weren’t cheering the news and the pound dived against the dollar.

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.

Pound investors will now look ahead to next week’s UK GDP figure, which could alter the mood for sterling.

Inflation concerns keep Fed Officials conservative

The US dollar rallied briefly against the pound after some data showed that the US labour market was continuing to show strong signs of recovery. US jobless claims rose by 8000 less than what analysts had anticipated. A business outlook indicator was also stronger than expected.

The data driven rally didn’t last long as investors instead focused on comments made by a voting member of the Federal Reserve, Robert Kaplan. Mr Kaplan said he was being patient about another rate rise, as inflation remained subdued. He would like to see inflation move closer towards the Fed’s target level of 2% before considering another rise.

His comments reflect the line of argument highlighted in the Federal Reserve minutes released earlier on in the week. Given the lacklustre inflation in the US a third rate rise is looking unlikely in 2017. Interest rate hike expectations fell following Mr Kaplan’s speech, which weighed on the dollar, pushing the pound US dollar exchange rate higher.

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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