With many of the questions much of the headlines are posing along with questions we are receiving from investors, we felt it timely to post a multipart series on the US dollar.
In order to keep this simple, it can get complex very quickly, we are going to focus on the main reasons for currency movement, in our opinion.
Currency fluctuations, in our opinion, are the result of interest rates. Interest rates are not the only determinate, but, in our opinion, interest rates drive the majority of the currency movement.
Interest rates, compared to other world interest rates, are one of the main drivers for currency fluctuation. (The carry trade, a topic for another discussion, creates much of the currency movement, again, in our opinion.)
Ok, so assuming you agree with the interest rate discussion, let’s compare the goals of two monetary governing bodies, EU and US.
From the Bank of England’s Website, it’s two core purposes: http://www.bankofengland.co.uk/about/corepurposes/index.htm
“Core Purposes – Monetary Stability: Price stability and monetary policy
The first objective of any central bank is to safeguard the value of the currency in terms of what it will purchase at home and in terms of other currencies. Monetary policy is directed to achieving this objective and to providing a framework for non-inflationary economic growth. As in most other developed countries, monetary policy operates in the UK mainly through influencing the price of money, in other words the interest rate.
The Bank’s price stability objective is made explicit in the present monetary policy framework. It has two main elements: an annual inflation target set each year by the Government and a commitment to an open and accountable policy-making regime.
Setting monetary policy – deciding on the level of short-term interest rates necessary to meet the Government’s inflation target – is the responsibility of the Bank. In May 1997 the Government gave the Bank operational independence to set monetary policy by deciding the short-term level of interest rates to meet the Government’s stated inflation target – currently 2%
Core Purposes – Financial Stability
The Bank of England has played a key role in maintaining the stability of the United Kingdom’s financial system for 300 years and it is now a core function of most central banks. A sound and stable financial system is important in its own right and vital to the efficient conduct of monetary policy.
Since 1997, the Bank of England has had responsibility for the stability of the financial system as a whole, while the Financial Services Authority (FSA) supervises individual banks and other financial organisations including recognised financial exchanges such as the London Stock Exchange.”
Now, from the U.S. FOMC website: http://www.federalreserve.gov/pf/pf.htm
“The Federal Reserve sets the nation’s monetary policy to promote the objectives of maximum employment, stable prices, and moderate long-term interest rates.”
As you can see there are a distinct difference in policy from the two governments, leading to dramatically different interest rate decisions.
Greater interest rate discussion in next part of the series.