What Drives Foreign Currency Movement?
Economic factors are the main stimulus behind currency movements. These factors can take many different forms, and often speculation surrounding a particular event can move currency rates as much as if the event actually happens. Often we hear of figures being released regarding sales, housing, employment or industry, but what do they actually mean? These figures are indicative of the state of the economy. For example, retail sales data for the UK would show how consumers here have been spending in Britain. If these figures are good it shows a lot of consumer confidence as a result of high spending. This could eventually lead to an increase in inflation – general price levels rising. A good way to combat inflation would be to raise interest rates to curb spending. If housing data released shows less mortgages approved or house prices falling, the Bank of England may well cut interest rates. This would be in an effort to stimulate the housing market. If base rates are cut it means borrowing will be less expensive, encouraging spending. We can see from the chain above how figures manifest themselves in interest rate decisions. This is almost always the case for all economic data released. It is not the actual numbers that move the exchange rate, but what they mean and what may follow as a consequence. Normally, due to the steady flow of data in the UK and detailed accompanying statements, economists can often make fairly accurate forecasts of the results of imminent data releases. Because of this we hear about figures “coming in lower than expected”. This would mean a prediction being more positive than the actual numbers released. When this happens we frequently see rapid market movement for a currency. The movement comes as expectations are “priced into” the foreign exchange market and when the predictions are contradicted, what was priced into the market unwinds, often very quickly. From what has been discussed above it is easy to see the effect interest rates can have on a currency. So who sets the interest rates in the UK and spending? What affect do they have on the pound? UK interest rates are set by the Bank of England’s (BoE) Monetary Policy Committee (MPC). The committee has nine members. On the first Thursday of the first full week of every month the MPC meet. They discuss the UK economy and vote on interest rate decision. They can vote to either; hike, hold or cut rates depending on their views on the economy. Having nine members ensures there is always a majority. If the MPC votes in favour of a hike (an interest rate increase) you will normally see the Pound ‘strengthen’. This will enable you to buy more of a foreign currency per Pound - foreign currency becomes less expensive. Cutting rates usually has the opposite effect. Markets view accompanying statements about interest rate decisions as importantly as the actual decision. Therefore, when these statements or meeting minutes are released, we normally see market movement.
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