Dollar Under Pressure Versus Pound As Fed Inflation Concerns Linger

12.10.17
4 minute read
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The pound’s recovery appeared to be running out of steam on Wednesday. With no relevant news through much of the previous session, the pound just about managed to hold its ground. However, a more conservative-sounding US Federal Reserve then pulled the dollar lower, boosting the pound’s exchange rate. Following the release of the minutes of the US Federal Reserve monetary policy meeting, the pound was trading 0.2% higher against the dollar at US$1.3233.

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 focus today for the pound is likely to be the Bank of England (BoE) third quarter credit report. The central bank has previously spoken of its concern over rising household debt, which it fears could spiral out of control. As the cost of living continues to rise while wages fall in real terms, consumers appear to be using credit to plug the gap.

The current low interest rate environment means borrowing money is cheap. Therefore, should the credit report show increased levels of borrowing, the BoE may be encouraged to raise interest rates in an attempt to discourage consumers from taking on more debt. With this in mind, if the report shows increasing levels of consumer debt, the pound could rally on the increased expectation of a rate rise.

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.

Inflation fears still causing doubts for Fed

The minutes of the US Federal Reserve monetary policy meeting in September ensured the dollar’s demise continued. On the plus side, the Federal Reserve is still aiming for a US interest rate rise before the end of the year. However, many policy makers were still worried about the risk of persistently low inflation and expressed concerns over how to best respond to it. Some of them said that they were also keen to see inflation rise higher before they acted again. Following the meeting, the odds of an interest rate hike fell down slightly to 80% from 85% earlier in the week. As market expectations of an interest rate hike dropped slightly, so did the value of the dollar.

So, in the near future, the outlook has only changed slightly. But looking ahead to early next year, the picture is more complicated, especially given the personnel requirements at the Fed. In February, Fed Chair Janet Yellen will complete her term and President Trump is still considering who should fill the vacancy. Furthermore, Fed Vice President Fischer has also handed in his notice before the end of his tenure, not to mention there are also other seats that need to be filled. So many unknowns in the leadership structure could weigh on the Fed as the end of the year closes in.

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