Dollar May Fall Against Pound as Fed Policy Decision Comes into View

Last week the pound jumped over 3% versus the US dollar. The pound US dollar exchange rate finished last week at a one year high for the pound at US$1.36 as traders continued to celebrate an increased possibility of interest rate action from the Bank of England (BoE). Moving into the new week, the pound appeared to be showing resilience as investors now look towards the US Federal Reserve for the next move.

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 US 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 US dollar’s worth versus the British pound. If the sterling number gets larger, it’s good news for the dollar.

The pound rallied in the later days of last week following the release of the minutes from the Bank of England monetary policy meeting. The minutes pointed to a growing unease among UK policymakers over the high level of inflation in the UK, which now sits at 2.9%. The majority view was that unless there was a sudden batch of poor economic data, then economic stimulus could be withdrawn in the coming months. Pound traders have interpreted these comments as an interest rate hike could be coming in November. As a result of increased odds for a rate rise, the pound rallied.

Why do raised interest rates boost a currency’s value?
Interest rates are key to understanding exchange rate movements. Those who have large sums of money to invest want the highest return on their investments. Higher interest rate environments tend to offer higher yields. So, if the interest rate or at least the interest rate expectation of a country is relatively higher compared to another, then it attracts more foreign capital investment. Large corporations and investors need local currency to invest. More local currency used then boosts the demand of that currency, pushing the value higher.

Looking across the week, this week is certainly quieter than last as far as the economic calendar is concerned. UK retail sales data on Wednesday could result in some volatility. However, the big event for the pound this week is set to be Brexit Speech by Theresa May on Friday in Florence. Should Theresa May show a strong preference towards a smooth, transitional Brexit as analysts expect her to, then pound could rally again into the weekend.

Why is a smooth Brexit good for the pound?
A smoother Brexit would be a scenario in which the economic consequences of leaving the European Union are minimised. This is favourable for the pound because the less the Brexit impact on the economy, the more likely that foreign investors will remain interested in the UK. Foreign investors need sterling to invest in the country and so the more GBP is purchased, the higher the demand and, thus, an increase in the currency’s value.

Can the US Federal Reserve revive the dollar?

A renewed show of defiance by North Korea at the end of last week had little impact on the dollar. North Korea launched a second missile over Japan on Friday, however the dollar, so far, hasn’t sold off as it’s done after previous attacks. That said, the buck is still looking weak, failing to even push higher after strong inflation numbers last week. Instead, investors are waiting rather cautiously until the end of the Federal Open Monetary Committee (FOMC) meeting on Wednesday.

While analysts aren’t expecting the US Federal Reserve to raise interest rates at this meeting, they are expected to give more detail on the unwinding of their $4.5 trillion balance sheet. This involves the unwinding of the bond buying programme, which was put into place during the financial crisis.

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