GBP/USD Disappointing Fed Reserve Comments Tank Dollar Under Pound

The pound U.S. dollar exchange rate soared for sterling on Tuesday as investors reined back U.S. interest rate expectations and UK banks were instructed to increase their financial buffers. The pound strengthened to a high of $1.2858, its highest level versus the dollar since the UK general election in early June.

What do these figures mean?

When measuring the value of a pair of currencies, one set equals 1 unit and the other shows the current equivalent. As the market moves, the amount will vary from minute to minute.

For example, it could be written: 1 GBP = 1.28934 USD

Here, £1 is equivalent to approximately $1.29. This specifically measures the pound’s worth against the dollar. If the U.S. dollar amount increases in this pairing, it’s positive for the pound.

Or, if you were looking at it the other way around: 1 USD = 0.77786 GBP

In this example, $1 is equivalent to approximately £0.78. This measures the U.S. dollar’s worth versus the British pound. If the sterling number gets larger, it’s good news for the dollar.

The Bank of England (BoE) ordered UK banks to increase the amount of money they hold to protect themselves against another financial crisis. Which means UK banks will need to add a total of £11.4 billion of financial buffers over the next 18 months to meet the requirements, as fears are growing over excessive lending and the amount of debt UK consumers hold.

Increasing capital buffers is a tightening of financial conditions, which actually serves to attract investor support of the pound. As the result, sterling moved higher versus the dollar.

Also adding to the pound’s gains was that the Scottish National Party has formally abandoned its plans to hold a second independence referendum before the end of Brexit. This move increases Britain’s political stability, which is pound positive.

How does political stability boost a currency?
Political stability boosts both consumer and business confidence, which means corporations and regular households alike are more likely to spend money. The increased spending, in turn, then boosts the economy. Foreign investors prefer to invest their money in politically stable countries as well as those with strong economies. For foreign investors to put their money into an economy, they need local currency. As they acquire the money needed, the demand for that particular currency increases, which then boosts its value.

Today, BoE Governor Mark Carney is speaking again, the time at the European Central Bank’s Central Bankers Forum. Given that Carney said nothing that changed interest rate bets when he spoke at the Financial Stability Report Conference yesterday, it’s unlikely he’ll make any pound moving comments today.

Demand for the dollar drops dramatically

The move northwards of the pound U.S. dollar exchange rate is more associated with a weakening of demand for the dollar, rather than a super strengthening of the pound. Several U.S. Federal Reserve Officials spoke on Tuesday, including Fed Chair Janet Yellen. The Fed is sounding less convincing about the U.S economy outlook, which is causing investors to scale back interest rate expectations. Although the message remains that interest rate increases will be gradual, the dollar pulled lower in response.

Additionally, the buck was weighed down by developments in Washington. A delay of the health care bill vote by the U.S Senate put significant pressure on the U.S. dollar. Trump’s failure to be able to push the bill through Senate suggests that the Trump administration will also have problems pushing through other policies such as tax reforms and infrastructure spending. The hope in Trumps dollar-boosting policies have supported the dollar’s rally since November, but now are looking very doubtful.

How would Trump’s policies boost the U.S. dollar?
A sizeable corporation tax cut would see a flood of money repatriated to the USA which would then create a high demand for the currency and, in turn, increase its value versus other currencies. Infrastructure spending in a country already close to full employment would also push wages higher, leading to more spending and thus boosting inflation. Higher inflation leads to higher interest rates and a higher demand for the currency.

Today’s U.S. economic calendar is light. Instead, investors will look ahead to Thursday’s final release of the United States’ GDP.

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