Inflation effect on exchange rates

Wednesday 15th January 2014 
It’s been a volatile week for exchange rates since my last post on Monday. Despite not much data other than some inflation numbers, we have seen Pound/Euro rise to 1.2070 before dropping back towards the 1.20 level. Against the Dollar, the Pound has fallen from $1.65 to $1.6350. 

In today’s post I’m going to analyse the reasons why the Pound has been fluctuating up and down, and where exchange rates may be headed in the short term. If you are looking to make a transfer from Sterling to a foreign currency, or convert a currency back into Sterling, then click here to find out about the rates and service that I can offer you. 

UK Inflation Figures cause volatility for the Pound 

Yesterday we saw UK Inflation figures released, and it’s this that has caused the GBP/EUR rate to fluctuate. The figures showed that inflation has dropped to 2% which is the government’s target. It’s the first time it’s been at that level for about 4 years. So what effect did this have on exchange rates? 

Before analysing the effect it had, let me explain how inflation figures can affect rates. Inflation is controlled by interest rates, so if inflation is high then interest rates would usually be raised to combat this, and vice versa. (Higher interest rates usually strengthen a currency as the higher return on offer attracts investors.) Several years ago this was usually the case, but since the financial crisis central banks have kept interest rates at record lows. Despite inflation running high of late, there was no expectation of a rate hike to combat it. 

Much of Sterling’s strength recently has been due to the improving economy, and the fact that economists think interest rates will soon rise in the UK due to falling unemployment. The low inflation number would however now indicate that there is less chance of an interest rate hike any time soon.

How did the lower figure affect Sterling?

Initially, the market reacted accordingly and the Pound fell slightly. This was probably due to the fact that economists said the fall would ease pressure on the Bank of England to raise interest rates following the recent recovery in the economy. 

However very quickly we saw this reverse, and the Pound actually rose back up again. So why did this happen? Well despite the figure being low and reducing the case for a rate hike, overall the news is actually good for the UK economy. As investors slowly realised this, the Pound became supported again and rates rose close to €1.21 against the Euro. 

As has been the case of late however, the rise in the rate was yet again short lived. Mark Carney faced MPs on the Treasury Select Committee today, and during the Q&A he has effectively poured cold water on a rate hike any time soon, so this has reversed the gains. At the time of writing, GBP/EUR is 1.2017 and GBP/USD is 1.6345. 

Where will the Pound head next in 2014? 

The next key data in my view will be on Friday, when we see the latest UK Retail Sales numbers. These are a good indicator of how the economy is performing as a whole, and I expect the figure to show a rise of 0.5%. If it’s higher than this, then expect Sterling exchange rates to rise. If it’s lower, we will probably see rates fall. 

Are you looking for the best exchange rates? 

I am a Senior Currency Broker for one of the UK’s leading foreign exchange brokerages, and update this blog to help people understand what moves rates. Did you know that I can also help you source exchange rates that are significantly better then banks and other brokers can usually offer?

In addition to helping you get better rates, you can also take advantage of the extensive knowledge I have of the currency markets. In this way you can make an informed choice on when to fix your exchange rate, and the best type of contract for you. 

I have helped thousands of clients get great rates of exchange for nearly 10 years. If you are keen on finding out more about what I can offer, send me a free enquiry by clicking here. 

I look forward to hearing from you. 

Alastair Archbold.

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