Dollar weakens post lower than anticipated inflation figure

This week has thrown us a couple of surprises from two of the best performing economies and both came in the form of inflation figures. First UK inflation came in higher than expected, and then yesterday US inflation came in lower than expected. Neither figure was wildly different to that which had been forecast – both only 0.1% out – but critically they were both different to those forecasts and even more critically the surprises were against the previous trends.

The reason these surprises are so important is all down to interest rates – higher inflation leaves room for interest rate rises, lower inflation doesn’t. Higher interest rates draw yield-seeking investment which strengthens a currency, whereas lower interest rates tend to lead to currency weakness.

In the UK the story we have heard recently has been one of interest rate rise hopes falling away into the future. This month’s open-book policy statement from the Bank of England showed us that MPC members were further from raising rates than expected, and so Sterling weakened. One of the factors behind this was an anticipation that inflation could take as much as two years to get back to the Bank’s 2% target. So when Tuesday’s inflation figure was slightly higher than expected, this cast this previous view point into doubt and the Pound rocketed as investors wondered if those rate hikes might come sooner than mid next year.

In the US the situation was almost a polar opposite. Interest rate hikes were expected next month or at the latest in October, so the Dollar was strong, winning battles across a broad range of major currencies. So when their inflation figure came in lower than anticipated, quite the opposite to the UK happened, the Dollar weakened. On top of this the minutes from the Federal Reserve’s most recent policy meeting were much softer than expected – inflation was expected to increase more slowly and external pressures were expected to be tougher. As a result Dollar support was becoming mush less stable and the Dollar weakened further.

Now this is great news if you have an upcoming Dollar requirement, as the Dollar is weakening, and the Pound is doing well. But not such good news if you have an upcoming Euro requirement… What the Dollar does, the Euro tends to do the opposite – a bit like a see saw. A weakening Dollar generally gives the Euro strength, and so it proved, and this is before we even report on the German’s ratifying the Greek bailout thereby removing the last main obstacle to it going through… The Euro was ascendant and that means even a boasted Pound couldn’t match it, and so GBPEUR lost over a cent by the close yesterday.

The day ahead sees UK retail sales figures, German PPI and US jobless claims, manufacturing and homes sales numbers – so plenty to digest. But with the big news mainly done for the week the trends could well be set and don’t be surprised to see the Euro push on.

Euro buying rates are only a couple of cents below the best rates for over 8 years, so all is not lost if you have an upcoming requirement, but it may well be advisable to discuss the possibility of a forward contract with your CI account manager to secure your rate ahead of any further drops.