The pound US dollar exchange rate has rallied for sterling as investors await a key speech from UK Prime Minister Theresa May on Brexit. The pound is back over US$1.3550 after briefly slipping following the Federal Reserve statement.
|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 was showing resilience as it charged higher ahead of a key speech by Theresa May in Florence, Italy. The speech will be a good opportunity for Theresa May to put her leadership and stalling Brexit negotiations back on track.
Brexit negotiations are not going anywhere quickly. Theresa May is expected to try to kick start talks again by making Britain’s position on Brexit clearer. She’s expected to confirm the desire for a transitional period and also offer €20 billion for the divorce settlement. However, markets will be most interested in what she has to say about how the government views the post transition period. In October last year at the Conservative Party Conference, May laid out her idea for a hard Brexit. She’s since become well-known for dramatic U-turns, and pound traders will be hoping that today sees another. Should Theresa May show signs of shifting towards a softer Brexit, then the pound could rally into the weekend.
|Why is a “soft” Brexit better for sterling than a “hard” Brexit?|
|A soft Brexit implies anything less than UK’s complete withdrawal from the EU. For example, it could mean the UK retains some form of membership to the European Union single market in exchange for some free movement of people, i.e. immigration. This is considered more positive than a “hard” Brexit, which is a full severance from the EU. The reason “soft” is considered more pound-friendly is because the economic impact would be lower. If there is less negative impact on the economy, foreign investors will continue to invest in the UK. As investment requires local currency, this increased demand for the pound then boosts its value.|
Following the US Federal Reserve statement on Wednesday evening the dollar rallied higher. This is because the Fed unexpectedly hinted that a December rate rise could still be on the cards. Furthermore, the Federal Reserve intends to hike rate 3 more times in 2018. Analysts and investors alike had assumed that the Federal Reserve would rein in its future interest rate projections given the US’s low inflation. This wasn’t the case Wednesday. And, as a result, Fed Chair Janet Yellen and company are happy to look through the inflation mystery and keep hiking rates, which boosts the dollar.
|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.|
If higher rates are good news for a currency, then why did the dollar fall? The fact that the dollar was unable to hold on to these gains suggests that dollar traders don’t believe that the Fed will be able to achieve this many hikes. This is also evident by the Fedwatch Fund which predicts only 2 rate hikes from now until the end of 2018. And even it isn’t even convinced on those 2 increase.
This article was initially published on TransferWise.com from the same author. The content at Currency Live is the sole opinion of the authors and in no way reflects the views of TransferWise Inc.