A perceived softening of stance by the EU towards the UK over Brexit talks boosted the pound on Friday. This pushed the pound US dollar exchange rate to a daily high of US$1.32 for sterling. However, the pound is still trading significantly lower than the US$1.3450 region, which is was trading at just one month earlier.
|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.
Demand for the sterling is being driven by politics. Brexit negotiation progress, or the lack thereof, has been a key factor pulling the pound off its recent US$1.3658 high in mid-September. However, a softening in tone at the EU leaders summit at the end of last week provided a boost to sterling. EU leaders said that insufficient progress had been made in negotiations so far, to progress to trade talks and transition deal talks. However, they also said that they will begin to internally prepare for this second stage. Investors have interpreted these comments as a positive sign that a transition deal could still be reached, which would pave the way for a pound-friendly smooth Brexit
|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.|
Apart from politics, the other big driving force is the central bank action. The Bank of England (BoE) is due to meet on the 2nd of November. The central bank has previously hinted that they could consider raising interest rates at the November monetary policy meeting. This week, the UK third quarter GDP data will be released. Analysts are forecasting an economic growth of 1.5% on an annual basis. The BoE has said that the UK economy needs to remain resilient in order for them to consider the rate hike. Should the GDP data show a weakening in the economy, the pound could then fall as the odds of an interest rate hike this year potentially diminish.
|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.|
The dollar was in demand at the end of last week as the US Senate passed a budget vote which will boost the chances of Trump’s tax reforms being pushed through. The tax reforms are pro-growth, which is beneficial for the dollar. Furthermore, the reforms will encourage the repatriation of huge sums of money from US companies because it proposes a sizeable cut in corporate tax in the US. This is also good news for the dollar.
Looking ahead to this week the US GDP data on Friday could potentially drive demand for the dollar. Gross domestic product (GDP) is the total value of everything produced by all the people and companies in the country and is the best way to measure a country’s economy. Furthermore, any declarations by Trump as to who will replace Federal Reserve Chair Janet Yellen could impact on the currency. The timing of the announcement is unknown but it could be as soon as this week.
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.