GBP/USD: Will US inflation finally tick higher after US economy grows 3%?

TransferWise content team
3 minute read

Both the pound and the US dollar were in demand in the previous session. This resulted in the pound US dollar exchange rate remaining broadly flat for most of the day. The exchange rate is heading into Thursday unchanged at US$1.2922.

As investors shrugged off concerns over North Korea and its recent missile launch over Japan the markets attention returned to economic data.

The pound was supported by news that mortgage approvals had increased by 5% in August, beating city analysts’ forecasts. The fact that approvals are up means that there is still life in the UK housing market, meaning UK consumers are still willing and able to spend. The British economy depends heavily on the consumer spending so any signs of a slowdown in spending would weigh on the pound. Instead sterling traders cheered the upbeat housing market news.

Why does strong economic data boost a country’s currency?
Solid economic indicators point to a strong economy. Strong economies have strong currencies because institutions look to invest in countries where growth prospects are high. These institutions require local currency to invest in the country, thus increasing demand and pushing up the money’s worth. So, when a country or region has good economic news, the value of the currency tends to rise.

Investors will now look towards UK consumer confidence data this morning. This number expresses how optimistic households feel about the economy as a whole and about their personal financial situation. When households are more optimistic they tend to spend more, which is good news for the economy and would boost the pound. Analysts expect today's data to show a decline in consumer confidence. The lower figure reflects households facing an increasing cost of living whilst wages remain stubbornly low.

US economy has strongest quarter since 2015

The dollar was enjoying a rare moment of increased demand on Wednesday. The dollar has been out of favour over recent sessions; geopolitical tensions and concerns that the Federal Reserve is not looking to tighten monetary policy further this year have been weighing on the dollar. However, as investors brushed off North Korea fears, attention turned to US economic data.

Both US second quarter GDP estimates and ADP employment data smashed expectations putting the dollar on solid ground. US economic growth gathered pace in the second quarter driven by consumer spending and more investment. The economy grew at the 3% figure predicted around by Trump in his Presidential campaign, but interestingly the growth was achieved without any policy progress in Washington. This shows that the US economic recovery is well on track, which has boosted the dollar.

Later today investors will turn their attention to US inflation figures. The Federal Reserve has spoken of its concern over the stubbornly low levels of inflation. Any signs that inflation is moving higher could send the dollar higher as it would increase the chances of another interest rate hike by the Fed.

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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