Thursday, 22 September 2016

Central Banks, Interest Rates, & Exchange Rates..

The Federal Reserve left interest rates on hold as expected last night which has given the Pound a little support, but not much.  The Pound was at a 5 week low, but has steadied a little. The FED did hint that a further rate rise is on the way before the end of the year, but there tone was a little dovish. This also weakened the USD and pushed GBP/USD up towards the $1.31 mark.

Central Banks, Central Banks, Central Banks.... 


Last night it was the US Central Bank that was the driver in exchange rates. Today, it's the UK and EU central banks. At 2pm the ECB president Mario Draghi gives a speech. Often his comments affect the Euro, and if he sings the praises of the EU economy and settles investor's nerves, then expect the Euro to gain strength pushing GBP/EUR lower.

Later at 6pm, it's the turn of the BoE governor Mark Carney to give a speech. We'll be looking for any hints at further rate cuts for the UK later in the year. If we get them, again the Pound is likely to remain under pressure.

Despite the slight gains for the Pound in the last 24 hours, I expect them to be limited. As I said earlier this week, the effect of the EU referendum on the economy is sharply back in focus after the Chancellor hinted he would give up access to the single market. The uncertainty about 'Brexit' hasn't gone away, and make come into closer focus in the coming weeks, keeping downward pressure on the Pound.

Why do interest rates affect exchange rates?


It's all to do with global investors moving funds around the world. Because the US are likely to raise interest rates again, the USD becomes attractive due to the higher return. Therefore, investors move funds to the USD to get a better yield. Vice Versa for the Pounds, as because the BoE may cut rates, Sterling is not attractive and therefore is sold and weakens. So in a nutshell, the rumour of higher rates strengthens a currency, and the rumour of lower rates weakens a currency.

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